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Eight years after the nation’s housing markets began tanking in the summer of 2006, one-fifth of the nation’s outstanding mortgage loans remain underwater, their owners indebted for more on their loans than their homes are now worth. Another fifth of our mortgagors have so little positive equity that they are effectively underwater. Look at particular cities and particular neighborhoods therein, moreover—especially neighborhoods of color—and you’ll find underwater loan rates of 50 percent or higher.
For the nation’s hard-hit cities, then, periodic, wishful talk of “housing recovery” is a bad joke. Among these cities is the nation’s largest—New York, where four of five boroughs fare poorly. As a new report issued last month by New York Communities for Change (NYCC) and the Mutual Housing Association of New York (MHANY) demonstrates, some 60,000 NYC home-owning families are in crisis, their underwater mortgage loans constituting 12 percent of total NYC mortgages. What, then, is New York to do?
Two weeks ago New York City Council Members Mark Levine, Daneek Miller, Donovan Richards, and Jumaane Williams, joined by me, NYCC, MHANY, and other housing advocates, called on the City to commence serious study of a solution to New York’s ongoing negative equity and associated foreclosure crisis that I have been pushing since 2007. It is a local solution patterned after a New Deal solution.
When President Franklin Roosevelt took office in March 1933 he faced two intimately related crises: a foreclosure crisis ravaging American homeowners and small family farmers and an epidemic of runs on troubled banks. A convoluted system of private mortgage finance, which even included an early form of what we now call “securitization,” had underwritten an excess-credit-fueled real estate bubble that paralleled the era’s better known stock market bubble. When the bubble burst, it left millions of Americans deeply underwater.
Underwater loans tend to default at high rates (today, at or near 70 percent). Resulting foreclosures wipe out not only homeowners, their families, and their communities, but their lenders as well. Foreclosure proceedings, after all, typically cost upwards of $20,000 in current dollars. Lenders during the Great Depression accordingly sought to modify underwater loans to cut losses and salvage what value they could. But a multitude of structural obstacles, stemming from our primitive system of private mortgage finance, prevented their doing so on an adequate scale. Millions of American borrowing families were thus rendered homeless, and their lending banks failed at such rates that the new President had to call a “bank holiday” upon taking office.
But Roosevelt didn’t stop there. Within his first three months of office, he introduced an institution that was authorized to partner with private investors and purchase underwater mortgage loans at fair value from banks that were unable to modify them, and then modify them. That institution was the Home Owners’ Loan Corporation (HOLC), founded in 1933, most of whose functions were later inherited by the Federal Housing Administration (FHA), founded in 1934.
Both HOLC and FHA proved so successful that they not only saved borrowers and lenders alike from default and foreclosure, they also turned modest profits in so doing—placing themselves among precious few government instrumentalities that have operated in the black. Along with the Federal National Mortgage Association (“Fannie Mae”) in 1938 and the Federal Home Loan Mortgage Company (“Freddie Mac”) in 1970, moreover, they brought us the stable, thirty-year fixed-rate mortgage, a system of mortgage default insurance, a stable secondary market, and a rise in the national homeownership rate from below 40 percent in 1933 to nearly 70 percent by the 1980s.
How did we fall into our present predicament, then? The answer is that deregulation in the 1980s saw the nation’s home loan bank industry wiped out. A new industry of barely regulated “mortgage banks” reintroduced complex new mortgage products that investment banks eagerly snapped up and securitized. Suddenly we were right back in 1920s territory. The FHA was sidelined and Fannie and Freddie privatized, forced to lower standards in order to keep up with the high-flying investment banks.
As in the 1920s, in consequence, the nation experienced twinned excess-credit-fueled stock and real estate bubbles, again facilitated by securitization. Also as in the 1920s, the bursting of the bubble left millions of homeowners deep underwater and apt to default, imperiling debtors and creditors alike. Finally, and again as in the previous era, ultimate creditors are unable to write-down mortgage debt to anywhere near the degree necessary. This is because modern securitization contracts vest control of the loans in trustees and loan servicers rather than investors, while simultaneously prohibiting the trustees from writing down or selling off underwater loans in adequate numbers. That might have seemed to make sense in the early 2000s, when some thought that house prices could “only go up,” but post-crash, it destroys value.
There is only one way to sidestep these securitization contracts, which now function as “suicide pacts”: eminent domain. For centuries, governments have used eminent domain to override dysfunctional contract or property arrangements that harm all but a few special interests. It makes sense for a government authority to partner with investors, as HOLC did, and use its eminent domain authority to enable the investors to reassume control of underwater loans and write them down (just as portfolio-loan-holding banks, which retain control of the loans they extend, do already).
The first version of this plan that I proposed, back when the crisis began, envisioned FHA, HOLC’s successor, as the appropriate government authority. But with Washington paralyzed, it seems clear that our cities will now have to play the lead role in bringing true housing recovery to the nation. That is a fallback which now seems a blessing in disguise: our cities have not only the sole politically feasible means, but also the most intensely felt incentives, to play the role HOLC did in earlier times.
Ultimately, how to proceed will be up to the full City Council and the Mayor, but it could go in a number of different ways. In my view, the best option is to establish an institution such as a land bank, empowered both to purchase and modify underwater loans to keep underwater residents in their homes and to purchase already-foreclosed properties with a view to reselling them to recently foreclosed residents. Look for deliberations to commence early next month.
I often say that there is “poetic justice” in using eminent domain. In the case that New York follows through with the plan, the City will be undoing harms done by Wall Street dealers to its homeowners and their communities during the mid-2000s. It will also be doing what New York’s own FDR did eighty years ago through HOLC and then FHA. Finally, the City will be reversing historic abuses in adopting the plan. In the more recent past, eminent domain has often been used to remove communities of color from their homes and their neighborhoods in the name of dubious urban “renewal” and “development” projects. In “taking the loans, not the homes,” New York will turn that ugly history on its head.
And as goes New York, so goes the nation.
Robert Hockett, Professor of Law at Cornell University and Fellow at the Century Foundation in New York, is a designer of the eminent domain approach to underwater mortgage debt. More on the plan can be found, e.g., in his recent paper for the Federal Reserve Bank of New York on the subject.
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