Eminent Enabler: Congress Prohibits HUD and Ginnie Mae from Facilitating Local Government Seizure of Mortgage Loans
At least for the next year, Congress has materially impaired the ability of local governments to seize underwater residential mortgage loans through eminent domain by cutting off federal insurance or guarantees to refinance the seized mortgages and then securitize the refinancings. Without this federal “take out” through mortgage insurance provided by the Federal Housing Administration (“FHA”), and guarantees of mortgage-backed securities by the Government National Mortgage Association (“Ginnie Mae”), local governments will have to find private sources of long-term funding to pay for loans that they attempt to seize.
Borrowers performing under non-conforming, non-governmentally insured, “underwater” mortgage loans have had a hard time refinancing their loans to take advantage of lower interest rates. The excessive loan-to-value ratio of the loans makes the borrowers ineligible for refinancing. Since the loans are neither government-insured nor owned by the GSEs, they don’t qualify for rate and term “streamlined” refinancings under government programs like HARP. If the borrowers defaulted on these loans or a default is imminent, they may qualify for loss mitigation relief. If they remain current, however, they generally will not qualify for loss mitigation based solely on the decline in the value of their home. Perhaps to force the hands of investors, local governments have looked to eminent domain as a back door way of providing current borrowers with loss mitigation relief.
Generally speaking, eminent domain is the expropriation of private property for public use upon the payment of fair market value for the seized property. There are many legal questions whether eminent domain could be used in this context, but the purely practical question has been from where does the money come for expropriating governmental actors to pay fair market value for the seized loans? See Consumer Financial Services Alert,”Bibbidi Bobbidi Boo: Eminent Domain Needs More Than a Magic Wand to Overcome Title Defects” by Laurence E. Platt. (July 24, 2013). Let’s take an example.
Assume a private investor owns a residential mortgage loan with an outstanding principal balance of $100,000 secured by a property that is worth only $70,000. The government would “purchase” the loan (through a forced sale) for $70,000, minus an amount for the government’s costs and expenses, including fees paid to the arranger. The source of the funds for the government’s purchase would be a short-term commercial loan, such as a revolving credit facility like a warehouse line of credit. As owner of the loan, the government then would reduce the outstanding principal balance of the loan by up to $30,000. With that reduced principal balance, the borrower then may qualify for an FHA-insured loan to refinance the modified original loan. Proceeds from the refinancing loan would be used to repay the local government’s short-term indebtedness, and the refinancing lender could pool the loan into a Ginnie Mae-guaranteed mortgage-backed security. Without the refinancing of the modified loan, the local government would have to use its own funds to pay off the short-term commercial loan. That’s not the plan.
If you take FHA refinancings off the table, the local government would have to find a private lender to provide the refinancing. But who will do that? Fannie Mae and Freddie Mac already have made such loans ineligible for purchase. There is considerable doubt whether private investors will purchase the paper; if not as a matter of principle, then because of uncertainty over clean title and an enforceable first lien based on the lawsuits that likely will surround the original seizure.
The FHA has been unsurprisingly coy about whether it would permit its program to be used in this way. While some HUD officials have expressed concern in Congressional testimony and in other public statements about the use of the FHA refinancings to facilitate eminent domain, HUD has continually said that it was premature to take a definitive stand. Now it doesn’t have to show its cards: Congress has neutered HUD from participating. The language in the recently enacted spending bill provides as follows:
“None of the funds made available in this Act shall be used by the Federal Housing Administration, the Government National Mortgage Administration, or the Department of Housing and Urban Development to insure, securitize, or establish a Federal guarantee of any mortgage or mortgage backed security that refinances or otherwise replaces a mortgage that has been subject to eminent domain condemnation or seizure, by a state, municipality, or any other political subdivision of a state.”
Now the language isn’t perfect; for one thing, it only applies for the funding period covered by the spending bill, which is limited to the federal government’s fiscal year 2015. In addition, neither FHA nor Ginnie Mae actually fund the making or acquisition of insured loans. In this context, funding presumably means the balance sheet treatment of governmental insurance or guarantees.
The bottom line is that local governments might still want to try to use eminent domain to force principal reductions in underwater home loans; they just won’t be able to pay for the controversial move through federal funding. That sounds eminently reasonable.