The prospect of dealing with the current problem of mortgages being under water using eminent domain as a possible solution strikes me as highly problematic. The way it would work is that local or regional governments would buy (seize) mortgages at ‘fair’ value, meaning a price reflecting current home values but at a discount (often a steep discount) to the face value of the mortgage. The government would then issue a new mortgage to the homeowner with a principal set at this lower value at which the mortgage was acquired.
Before explaining my thoughts I’d like to go on record by saying that this is clearly a serious and difficult challenge and I do not have a solution. I mention this because it would be far preferable to at least discuss potential alternatives or solutions when discussing the negative implications of other solutions that have been read. But, in the absence of being able to do that, I feel I’m left with no other alternative than to voice my concerns.
The big problem with eminent domain as I see it is that it seeks to avoid a contract because one party has been harmed. Someone decides they want to buy a house. They go to the bank, get a loan, and buy the house. Let’s say they buy the house for $100,000. Two years later the house is worth $80,000. It was the prerogative of the buyer at the time to decide that he liked the house and liked the price. The lender took on risk by assuming that the buyer would pay him back and in the absence of doing so would return the underlying collateral for the lender to decide what to do with. It is admittedly unfortunate the lender in this case tends to be a large bureaucratic organization that doesn’t have the flexibility to engage the buyer and renegotiate a mortgage if that really is appropriate thing to do. Having said that, this is probably a discussion for another day.
So what’s the problem with using eminent domain? Well, I liken this to a set of different examples. Example 1: I see a computer system that I would like to own and see that it is $5,000. I go ahead and put this on my credit card and pay $5,000 for the computer system. Let’s say, for example, that 15 days later there are competing computer systems that are comparable and the computer system that I like has fallen in price to $2,500. I do not and should not have the ability to go back to my lender, the credit card company, and say, “The current price on the market for this is half of what I paid, therefore I am going to unilaterally decide to only pay you only $2,500.” I liked the unit, decided the price was acceptable, took out a loan and I have agreed to pay that loan back. Example 2: I see a stock that I believe is attractively valued, stock XXX. It’s trading for $100 per share. I buy stock XXX and 3 days later on settlement date, the stock is now trading for $80 per share. Clearly I am required to pay the $100 per share that was the prevailing price when I entered into the transaction and I absolutely do not have the ability to say that it is currently $80 per share and I am voiding the transaction and paying the current prevailing price. Eminent domain in effect seeks to accomplish what is occurring in these two examples.
Again, this is far more complex than the simple examples that I have mentioned. However, the complexity doesn’t change the fact that much of the nature of the transaction is very similar in all of these examples. I acknowledge that there is potentially a societal good from using eminent domain as it is currently being discussed. I simply want to emphasize that there are victims to doing so. The victims specifically include the lenders in any transaction. Additionally, I would argue that the victims include the entire financial system. In the future, if I am a lender, I need to worry about whether an authority figure, specifically the government, will at some point have the right to step in and renegotiate (or more correctly, unilaterally reset) the value of the loan that I, the lender, offered.
I do not in any way say this lightly, nor do I dismiss the possibility that ultimately eminent domain may be the right solution. However, I would emphasize strongly that anyone who uses it, or advocates it, at least recognize the serious negative implications. In the absence of doing so, advocating eminent domain seems to me very much like asserting that shoplifting is a victim-less crime. Joe Nocera, for whom I have great respect, has written an op-ed piece in the New York Times on eminent domain. Having shared my perspective, I think Mr. Nocera’s piece is interesting and worth reading.