Kanner’s recent analysis  — “Stop the BS About Underwater Mortgage Eminent Domain Takings” — on his website Gideon’s Trumpet tells a different story than what most of the public is reading in the mainstream media. Kanner calls most of the people writing on the subject “clueless” for several reasons.

What clueless media never explain

First of all, Kanner points out that the city of Richmond will have to pay just compensation to lenders — not some “bargain basement figure pulled out of thin air” so that the city and its mortgage carpetbaggers can reap a windfall.  And this compensation has to be deposited in full at the start of the eminent domain action.  Citing Article 1, Section 19 of the California Constitution, Kanner says: “the ‘just compensation’ called for in the state constitution has to be ‘first paid’ – in full, and up front, that is – before any taking can occur.”  Apparently, cash-strapped Richmond is going to borrow the money from its mortgage advisors to make this upfront payment.  This means the city will have to go into more debt.

As pointed out by me elsewhere, this will mean the city will have to pay back its mortgage consultants’ investors instead of the investors of the banks that hold the mortgages.  Whether the courts would allow mortgage lenders to be stiffed to enrich mortgage consultants working for cities is doubtful.

Secondly, Kanner says Richmond will have to pay “fair market value” which is defined as the “highest price” and not some bargain price coerced from a seller under duress of the eminent domain law.  In other words, Richmond and its mortgage partners cannot pay a low-ball price to make a profit for themselves on the backs of lenders.

Kanner says that if Richmond’s “harebrained scheme becomes a’cropper, as it likely will, for one reason or another, it won’t be the first time Richmond got its greedy finger burned playing with eminent domain.”  Kanner cites the 1977 case of Richmond Elks Hall versus the City of Richmond Redevelopment Agency (561 F. 2d 1327 – 9th Circuit).  This case is one of the leading cases of eminent domain abuse in the state wherein the courts ruled against a city trying to pick up properties on the cheap.  The court rejected Richmond’s low-ball compensation in that case.

Eminent domain arbitrage: buy low, sell high

According to the compensation formula reported by the city’s mortgage advisors, the city can only make mortgage eminent domain work by arbitraging –– buying the mortgages at the lowest price and then allowing its mortgage middlemen to sell them for the highest price.  Courts have historically rejected the tactic of cities trying to to downzone a property so it could be condemned on the cheap.  The same principle of banning municipal arbitraging would likely apply to the city of Richmond.

Richmond would also have to pay damages to lenders for any losses to their whole loan portfolio.  Kanner says that Richmond’s scheme to take only mortgages where the homeowners are making payments would leave lenders with only bad mortgages that are in foreclosure.  Thus, Richmond would likely have to pay damages.  In my experience as an appraiser for a large public utility, sometimes damages can exceed the whole value of the property.

Richmond will also have to pay its own attorney fees.  And if the city loses each court case, it will have to pay the lenders’ attorney fees.  It typically costs a minimum of $50,000 for legal representation in eminent domain cases. Damages and attorney fees alone could eat up all the profit that Richmond and its mortgage consultants expect to make.

Where is the condemnation of condemnation?

Kanner views the upcoming eminent domain trials as “spectator sport” brought about by harebrained academics, greedy mortgage consultants, “big shot lawyers” who are ignorant about eminent domain law, and cash-strapped cities who hope to plug holes in their pension plans with ill-gotten gains from eminent domain.  The city of Richmond thinks it would reap $48 million under this scheme. To imagine what Richmond is doing imagine the city of Bell in Los Angeles County using eminent domain to fund fat-cat salaries, perks and benefit plans for the City Council and its cronies.

Mortgage eminent domain in Richmond is likely to backfire in a big way.  Are elected leaders in Richmond prepared for recall elections when all this backfires on them?  Stay tuned.

By Wayne Lusvardi

As the July 4 holiday approaches, America celebrates independence from the tyrannical taxation and subjugation of Great Britain in the 1770s.  But property owners in California have no more property rights even after a new U.S. Supreme Court case has apparently expanded the right to just compensation to “non-takings” of property.

The case is Koontz vs. St. Johns River Management District. A statement by Pacific Legal Foundation Principal Attorney Paul J. Beard II, who argued on behalf of Coy Koontz at the U.S. Supreme Court, explained the case:

“Today’s ruling says the Fifth Amendment protects landowners from government extortion, whether the extortion is for money or any other form of property….

“The court has recognized that money is a form of property, and the Constitution prohibits grabbing money from property owners the same way it prohibits grabbing land without compensation.

“The Koontz family sought permission to develop a few acres in Central Florida, and they were told they must spend up to $150,000 to improve the government’s property, miles away from the Koontz family’s land. This demand was far in excess of any impact that their land use proposal would create.  They fought this injustice in the courts for nearly two decades, and today they have won a landmark decision, for themselves and all property owners.  Their victory protects all permit applicants from government extortion.  Everyone who values constitutional property rights owes the Koontz family a debt of gratitude for this historic victory.”

However, New York University law professor Rick Hills described the decision using the metaphor of a land war that bogs down an army so long that it cannot achieve victory.  According to Hills, local overregulation, taxation and extortions of property owners remain unchecked after the Koontz case and other so-called landmark property rights cases.

The Koontz Case

In the case, landowner Koontz wanted to develop a portion of his Florida wetlands property.  The local Water Management District refused to approve his project until he made certain concessions, such as improving public lands elsewhere.  Koontz felt the conditions so excessive that it made it impossible for him to develop his property.

No land was physically “taken” from him that would require just compensation to be paid, as required by the Fifth Amendment to the U.S. Constitution.  Rather, regulations and fees were added as a condition of any development.  Where such conditions are unconnected to the reasonable impacts of development, it is called a “regulatory taking” in the law.

For instance, if a new proposed shopping center development will create excess traffic impacts necessitating widening the street, it is reasonable and proportionate to require a developer to dedicate land and pay street widening costs.  This is called a legal “exaction.”

However, it would be unreasonable and disproportionate to require a shopping center developer to improve streets elsewhere in town that should be maintained from a city’s road funds. That is often called municipal “extortion.”

But in the Koontz case, nothing was actually taken, nor was there any impact directly connected to the development of the Koontz property.  Instead, burdens were added unconnected to any impacts.  These burdens included buying or improving wetlands elsewhere or paying “in lieu” fees for government to enhance offsite wetlands.

In some cases, such conditions can be nothing more than shakedowns to collect fees that can be “money laundered” into city coffers to pay pensions or other costs of local government unconnected at all to their stated purpose.

As Hill aptly said, “The problem is not merely distinguishing taxes from takings but also distinguishing all other routine conditions on land-use permits (such as obligations to pay affordable housing, finance public plazas, bank wetlands, hire local folks for construction jobs, improve subway stops, etc.) that are the routine currency of conditional map amendments, conditional use permits, variances, Planned Unit Development (PUD) approvals, and the like.”

Why no property rights: No enforcement or legitimacy

The reason that there are no effective property rights at the local level, according to Hills, is that there is no state or local property rights court system to enforce such rights.   According to Hills, federal courts lack the funding, manpower and electoral legitimacy to pull off such an “act of imperialism” over local land use authorities.

Judges lack legitimacy to overrule municipal government land use decisions because they have to get elected.  And the greatest influence on local community power structures is real estate development interests.  The U.S. Supreme Court keeps issuing decisions in favor of property rights, but there is no enforcement mechanism.

That is the situation of property rights in California, especially for small landowners who do not have the resources to fight city halls. In California, one person’s claim of “expropriation” is another’s “property right” which politicians have given away to voters to maintain themselves in power.

Hill points out, however, that in Pennsylvania and Washington, state courts are more aggressive in policing local land use regulation.

The only possible, albeit unlikely, solution to restore private property rights in California, according to Hills, is to establish a federal court that could directly rule in local land use decisions.  This, however, would violate the long established principle of federalism, whereby states have rights to make and adjudicate their own laws.

Koontz Case is “Dead Letter”

Contrary to all the media reports of a property rights victory, Hills calls the Koontz case a “dead letter,” meaning a law or court decision still formally in effect but no longer valid or enforced.

Private property rights in California on July 4, 2013 mostly exist only on paper as long as the media continue to cast a blind eye to its ineffectiveness.  As long-time California eminent domain attorney Gideon Kanner writes on his blog, “Gideon’s Trumpet,” in reaction to the Koontz case:

“Which brings us to a perplexing question: why are liberal judges who profess a devotion to a ‘living constitution’ that protects people from an overreaching government, so fiercely committed to a kleptocratic mode of governance in which anything that tends to plunder private wealth, including modest wealth of ordinary people, is deemed such a great public good? If you figure that one out, please do let us know.”

By Wayne Lusvardi

What are called “nail houses” in China may be coming to the county of San Bernardino in 2013 by using eminent domain as a bail out from unfunded public pension debts.

The photo at right shows a property that has gained worldwide attention as a holdout from a freeway construction project in China.  A now famous duck farmer owned the home — recently demolished after the owner finally “accepted” the Chinese government’s offering price.  Holdout houses in China are called “nail houses” because homeowners refuse to be “hammered down” in price.

Mortgage Resolution Partners is a private mortgage hedge fund manager hired by the county of San Bernardino. It now has vowed to move ahead with its controversial plan to use eminent domain to buy out “underwater mortgages” from lenders. MRP’s plan is to take the mortgages by force of eminent domain law from lenders, reduce the amount owed on each loan and let the homeowners continue to live in their homes while making lower payments.

In San Bernardino County, it is mortgage lenders holding so-called “underwater mortgages” that are resisting being hammered down in price for their mortgages. Lenders are not going to sit still and allow performing mortgages to be taken “on the cheap” so that some politically connected mortgage consulting firm can reap an estimated $135 million windfall without a fight.

MRP would get a set fee of $4,500 per loan write down for some 30,000 underwater mortgages. It is estimated there are 150,000 underwater mortgages in the county where the loan owed is higher than the market value of the home.

As renowned California eminent domain attorney Gideon Kanner wrote on Nov. 27:

“[I]t seems likely that the realization has sunk in that the exercise of the power of eminent domain requires payment of just compensation. Evidently no one has thought through what that would entail quantitatively, and no one is eager to put up the money required to find out. Remember that the statutory “fair market value” that is the usual measure of “just compensation” requires payment of the highest price the property in question would bring if sold in a voluntary transaction by a knowledgeable but unpressured seller to a knowledgeable but unpressured buyer. And, as far as we can tell, nobody knows what the highest price of an underwater but performing mortgage is.

“Our perception is that at first, the promoters of this scheme saw it as easy pickings; they would pick up some performing but underwater mortgages at way below their value and clean up by letting the occupant-homeowners take over the debt service using a lower mortgage balance. But apparently, performing mortgages cannot be picked up for peanuts even if they are underwater. They represent a cash stream which no one is going to give away.” 

Who Would Pay Off Lenders?

Even if MRP could legally pull off taking mortgages from lenders, there are additional, near-insurmountable, problems.  Who would pay the lenders for the difference between their loan value and the write-down value? It is likely the county would have to float a general obligation bond to be paid off by all property owners on their tax bill.  This might trigger Proposition 218, which requires any tax to be put to a vote.

According to the U.S. Census, there are 702,060 housing units in San Bernardino County.  Whether the county and MRP could persuade 552,060 homeowners without underwater mortgages to vote for an in increase their property tax obligation by an estimated $27,710 per property is highly doubtful.

MRP and the County know there is no magic hammer in eminent domain law that can make disappear the amount of the mortgage over the home’s market value without having to pay for it.  They apparently believe they can influence a judge to relax the definition of Fair Market Value so that eminent domain can be used as a bailout.

The mortgage industry, the local real estate industry, and even the federal government are opposed to the abuse of eminent domain law in this way. Even if taking mortgages is somehow deemed lawful, it would lead to instant disinvestment in the county and other property owners would likely be unable to sell their homes. But governments in California are apparently concerned about saving their own skin, not that of homeowners.

Desperate Governments are Seeking Legal Hammer

The city of San Bernardino and many other cities in the county are desperate. The city of San Bernardino has filed for bankruptcy.  It has also stopped making its bi-weekly $1.2 million payments to CalPERS for public employee pensions. In turn CalPERS has filed suit for the amount of the pension obligation in arrears. The city of San Bernardino is a worse case than the bankrupt city of Stockton, which chose to keep making CalPERS payments.

San Bernardino’s unfunded pension obligation is reported at $143 million. But that would rise to $319 million if the city wanted to exit CalPERS.  Cal-PERS wants to conduct its own sort of eminent domain action by using the force of a court action to collect the city’s contributions to its pension fund over all other obligations.

If CalPERS is able to get first dibs on the city’s treasury, the city attorney has warned residents not to rely on the hammer of the law to protect them but to “lock their doors and load their guns.” The reason: There won’t be enough money left for police protection if full public pensions need to be paid. This is probably not just a verbal threat to influence public opinion about the bankruptcy and CalPERS lawsuit. The giant wave of unfunded pension debt now pressing on the city would result in their not having enough money to fund but a skeleton crew of police and firemen.

CalPERS could bring about the unraveling of the rule of law in San Bernardino.  The city attorney has pointed to the rising murder rate in the city as a signal of what the city is facing in the future.

Look for Pounding Out of Market Value Loophole 

MRP has been working with the city of San Bernardino, liberal academic legal experts, CalPERS and law firms for months trying to devise a way to use eminent domain law to take selected mortgages from lenders on the cheap.  As someone who was an eminent domain appraiser for 20 years, look for MRP’s attorneys to exploit the rarely used alternative definition of Fair Market Value in California’s eminent domain law, which states:

“The fair market value of property taken for which there is no relevant, comparable market is its value on the date of valuation as determined by any method of valuation that is just and equitable. (Source: Section 1263.310 (b) — California Code of Civil Procedure).  

The words “just and equitable” in the above definition are likely to be twisted to bang open the court door for the use of eminent domain for social justice bailouts. Attorneys representing mortgage lenders, local realty associations, or property rights groups should anticipate that MRP might base its use of eminent domain on the above loophole.  The conventional definition of market value is a closed door that probably can’t be hammered open to meet MRP’s objectives.

County Property Owners are Nails for Hammering

Who is eventually going to get hammered down — countywide property taxpayers, CalPERS or mortgage lenders?  That remains to be seen. Right now it is a legal game of who ends up getting to hammer the other money players. San Bernardino County property owners need to be vigilant because neither the city nor the state nor CalPERS wants to take a hit from a hammer.

That makes property owners a vulnerable target for some sort of “creative eminent domain” that shifts the city’s pension obligations onto them. Look for the rise of a property owner movement in the county to protect homes from having to take to hit of about $27,710 in debt added to each home (with interest it would likely be about three times as much over 30 years).

Paraphrasing a popular proverb: “If all you have is a hammer, everything may become a nail house” in San Bernardino in 2013.

By Wayne Lusvardi

Will Americans be protected from eminent domain abuses? Eminent domain is where the government takes someone’s property, usually for a government purpose, such as building a school or road. But sometimes eminent domain is abused to take private property and give it to a private company, such as a big-box store or housing development.

Last week, California Lt. Gov. Gavin Newsom’s told mortgage banks and agencies of the federal government to “back off” from their opposition to the use of eminent domain in California to take “underwater mortgages.”

In response, on Sept. 13 Rep. John Campbell, R-Irvine, introduced the “Defending American Taxpayers from Abusive Government Takings Act” (H.R. 6397).  It would block local governments from pursuing the condemnation of so-called “underwater mortgages,” as is being proposed in San Bernardino County and elsewhere in California.

Campbell’s bill would work with secondary mortgage market lenders Fannie Mae and Freddie Mac, the Federal Housing Administration and the Veteran’s Administration to bring about mortgage reductions. The Federal Housing Finance Agency, overseer of both Fannie Mae and Freddie Mac, had threatened to take action against the use of what might be called “submerged eminent domain” before Rep. Campbell proposed his bill.

Underwater mortgages are really “over-mortgaged” loans where the amount of loan owed on a property is much higher than the current market value of a home.

For example, Campbell points out that San Bernardino County’s proposal would provide an incentive to appraise properties with underlying seized mortgages as low as possible to increase their potential profit to mortgage re-financiers. Stated differently: profiteering would be submerged out of the scrutiny of the public in rigged real estate appraisals.  What might be called “submergible eminent domain” would be used for underwater mortgages.

Campbell called such schemes “atrocious, corruptive, irresponsible and unconstitutional.”

Another Difficulty — A Tax Bill for Mortgage Reduction

The civil war over the use of eminent domain to acquire underwater mortgages has gotten almost all the media attention.  What has received less attention is the pending expiration of temporary federal legislation passed in 2007 that suspended the tax liability of homeowners who receive mortgage reductions of up to $2 million.

In 2007, Congress passed the Mortgage Forgiveness Debt Relief Act, which expires at the end of 2012.  There is discussion to extend it, but Congress only has three months to act.  Newsom has made no known advocacy to extend the Debt Relief Act.  Instead he is championing the questionable use of eminent domain law to buy out underwater mortgages.

Creative Appraisals Proposed In-Lieu of Eminent Domain

Steven Gluckstern, chairman of Mortgage Resolution Partners, a private hedge fund proposing to condemn underwater mortgages, has proposed another “doozey” of a concept.  It would involve using creative appraisals instead of eminent domain to reduce mortgages.  Here is the Sacramento Bee described an example of his:

“A homeowner paid $300,000 for a house during the boom. That house is now worth $200,000, with a mortgage balance much higher than that. A city would seize the mortgage and pay the note holder $160,000. Gluckstern contends that would be fair-market value, after the potential costs of foreclosing on the mortgage are deducted.”

“The idea is not for the city to become a lender. Instead, he said, the homeowner would refinance his mortgage at $190,000, with help from Mortgage Resolution Partners. The extra $30,000 would be split between investors, local government and MRP, which would make a flat fee of $4,500 per transaction.”

A representative of the Securities Industry and Financial Markets Association called the above-described proposal a scheme for “short-term opportunistic investors to make a 20-to-30 percent profit” by “cherry pick(ing) the best loans out of a securitized poor and buying at a substantial discount.”

Prominent eminent domain attorney Gideon Kanner on his blog on Aug. 17 said, in reaction to the creative appraisal concept:

“Nobody seems to be asking why the awesome sovereign government power of eminent domain should be enlisted in quest of quick private profit…the public interest must predominate and the private benefit is limited to being incidental to it, as the court explained in [the case] County of Los Angeles vs. Anthony.” 

Kanner also asked what public interest is served in the above refinancing example when the loan in question is that of a performing mortgage where payments are being made.

Kanner also noted that, once the Pandora’s Box of eminent domain is opened up for underwater mortgages, the property owners could not be denied hiring their own attorney and appraiser and contesting any mortgage buyout or reduction offer.  If they won in front of a jury, the local government agency would be on the hook to pay court costs and the property owner’s litigation and appraisal fees.  This is minimally about $50,000 per case.

There is No Underwater Mortgage Free Lunch

The use of so-called “submerged eminent domain” has become a trendy cause by media elites Arianna Huffington and actor John Cusack.  However, no mention has been made that, in San Bernardino County, the proposal to use eminent domain would call for about 80 percent of all property owners to vote for higher property taxes to pay off the underwater mortgages of the other 20 percent of homeowners.

How long the concept of using eminent domain to reduce “underwater mortgages” would remain popular when all homeowners in a designated area would have to vote for higher property taxes remains to be seen.

By Wayne Lusvardi

In San Bernardino, the county has approved using eminent domain to seize bank-owned pools of “underwater mortgages” to get the county out of its over-indebted housing stagnation. The city of San Bernardino has the second highest poverty rate in the United States, after Detroit.

The cities of Fontana and Ontario have also approved joining the program.  The city of Hesperia, however, rejected the idea.  But such a bailout of underwater mortgages is likely to result in a number of foreseeable negative unintended consequences.

What happens if the county buys up underwater mortgages, but home values plunge again due to a double-dip recession triggered by an economic disaster, perhaps the European debt crisis? Economist Gary Schilling, who has called every recession correctly since the 1970s, is forecasting another 20 percent drop in national housing prices in 2012.

But this isn’t deterring those like John Husing, the chief economist for the Inland Empire Economic Partnership in San Bernardino, from promoting the notion of using eminent domain to acquire underwater mortgages and re-sell them to hedge funds.

Use of eminent domain to force loan write downs is the apparent brain child of Cornell University Professor of Law Robert C. Hockett in his June 2012 paper, “It Takes a Village: Municipal Condemnation Proceedings and Public/Private Partnerships for Mortgage Loan Modification, Preservation and Local Economic Recovery”.

Investopedia.com defines an underwater mortgage as “a home purchase loan with a high balance owed than the free market value of the home” on the open market. Homeowners with underwater mortgages typically cannot resell their homes unless they can come up with the cash to pay the loss off.

The median single-family home price in San Bernardino County is $158,500, as of May 2012.  The median home price in San Bernardino-Riverside Counties as of 2007 was $343,250. This reflects a 53.8 percent decline in value from the peak of the Housing Bubble.

Steven Gluckstern of Mortgage Resolution Partners, a private hedge fund proposing to batch the mortgages and re-sell them at a discount, says that roughly $1 billion would need to be financed to initiate eminent domain proceedings on 5,000 underwater mortgages.  The homes themselves would not be condemned.  That would reflect roughly $200,000 per home in loan write down needed.

Consider a home with, say, $315,000 loan balance as of 2012 — 50 percent its original value. In that case, a 60 to 70 percent loan discount would be indicated to provide a third-party investor a 10 to 20 percent profit. But this would result in a sale at less than the median home value of $158,500 today. It is not clear if homeowners would lose their rights to any future appreciation in their home as part of this deal.  If so, perhaps the entire property would need to be condemned as well.

A Redevelopment Agency for Over-Indebted Homes

The proposal to acquire underwater mortgages comes from Mortgage Resolution Partners, a San Francisco based group of venture capitalists. Mortgage Resolution Partners is led by CEO Graham Williams, who created Bank of America’s “award winning” Neighborhood Advantage low-income housing initiative.  Bank of America’s Neighborhood Advantage Program was essentially a “zero down” sub-prime loan program.

Reportedly, 150,000 homeowners have underwater mortgages in San Bernardino County.  About 20 percent of those mortgages — or 30,000 loans — are held in private mortgage-backed securities that could be acquired by eminent domain.  The eminent domain process would be funded privately. The re-selling of mortgages to hedge funds would be handled by private venture capitalists for a profit. But the county would hold the mortgages in a public/private joint powers agency.  Call it a “redevelopment agency for over-indebted homes.”

Eminent domain legal expert Gideon Kanner believes that eminent domain law is so broad in California that it could be stretched to allow the acquisition of underwater mortgages and still meet the legally required “public benefit” test.

Technically speaking, however, it is likely that a city could only legally condemn that portion of a mortgage that was “underwater” and not the whole loan. It would be unlikely that a “public benefit” could be justified for taking the portion of the loan that is not “underwater.”  This would be what is called a “partial taking” or “fractional interest taking.”  How that could be determined on 5,000 to 30,000 mortgages could be a logistic nightmare.

A ‘Lousy Idea’

But Kanner stated on his blog that this is a “lousy idea for a number of policy reasons”:

First, the county as condemnor would have to come up with the money to acquire the mortgages by a public-private partnership that would issue some sort of mortgage revenue bond.  Public-private partnership is a code word for what used to be called “redevelopment” in California until Gov. Jerry Brown and the state Legislature shut down redevelopment agencies in 2011.

Second, the standard for “just compensation” in eminent domain is Fair Market Value.  But banks and private mortgage lenders hold mortgages on their books for their higher “book value.”  The open market value of the homes serving as collateral for an underwater mortgage would be lower than the “book value” of the loans.

But you can’t use eminent domain law to acquire a home, or a mortgage, “on the cheap” at less than the balance owed on the loan.  The concept of just compensation is to “make the property owner whole.”  So eminent domain probably can only be used to force banks to sell their loans at full book value, not at a discounted value.

Nonetheless, mortgage loans would have to be sold at a discount in order for private investors to make a profit.  Thus, the county would have to be willing to buy loans at their face value and sell them for much less. The spread is called a discount, which reflects the margin of profit to the seller of the loans.

Steve Body, a commercial real estate appraiser and securities trader in Eagle Rock, California, stated that the expected discount on underwater mortgages would probably not be as low as the typical 10 to 12 percent in bankruptcy court.  He said it would also not be as high as 50 percent found in highly distressed assets.  That is because most homeowners with underwater mortgages are making their loan payments.  He believed a discount in the 20 to 40 percent range would be typical.  But Body stated that, paradoxically, if a public entity buys and guarantees payment on the loans, there would be less risk and thus less of a discount or profit for investors.

Both Body and Kanner mentioned that there would be another big impediment for banks selling their loans even at their full book value. Coercing banks to sell a portion of their loan portfolio might drop bank reserves to less than the minimum reserve of stress tests required by bank regulators.

Body cautioned that another impediment for banks could be what is called “fractional interest banking,” where banks loan out the same money, say, seven or eight times.  Could banks demand just compensation for the lost opportunity cost of a multiple of the book value of the loans? What bank would agree to a voluntary condemnation of their underwater mortgages and forego such profits?

Kanner warned of a repeat of the Savings and Loan Crisis of the 1980’s and early 1990s, when savings and loan banks had to sell their junk bonds at fire-sale prices by order of the federal government.  This resulted in the collapse of several savings and loan banks. 

Hazard of Non-Payments

But Kanner warns of even more “calamitous consequences.” There is hazard in reducing the loan balances on mortgages if borrowers are provided an incentive to stop making payments on their mortgages, hoping to get bailed out by the government.

And then there is the potential problem of the mass flight of property owners dumping their homes once their loans are reduced — to get out of California or take better jobs elsewhere.  Think of government-reduced mortgages as a one-way ticket out of San Bernardino.

And then there would be the prospective slippery slope problem that, if this were implemented in San Bernardino, where would it stop?  Other distressed counties would be politically pressured to reduce all the underwater mortgages in their jurisdictions, too.  A house of cards could result in the entire housing market collapsing.

And loans would likely be re-sold into a mortgage market at the same time as the federal government is dumping foreclosed homes on the market.

The proposal to use eminent domain to reduce over-indebted homes is filled with multiple unintended negative consequences.  But these consequences are foreseeable and thus potentially avoidable. Desperate cities should beware of hedge funds offering bailouts.