Callling San Bernardino's proposed use of eminent domain stupid may be kind

California’s San Bernardino County is considering imposing eminent domain to seize underwater homes. The county has a foreclosure rate four times the national average. The objective county would purchase underwater mortgages then offer the homeowners the restructured mortgages. However, instead of seizing mortgages that are in foreclosure or those in danger of foreclosure due to missed payments, the plan would seize only those homes whose homeowners are current on their mortgage. Huh? I presume that this is because investors would be leery of purchasing mortgage whose homeowners have demonstrated either the inability or unwillingness to pay. The Heritage Foundation, which is usually on top of such issues has a curious discussion that only concentrates on the legal aspect. Its analysis concentrates on the Takings clause which is invoked where the property is seized over the opposition of the owner. Running afoul of the Takings clause could be easily avoided if the County only acquired the property of just those homeowners who agreed to have their property “seized”. Many of the news reports have concentrated on other issues. Some of the newspapers and blogs have questioned the use of San Francisco’s Mortgage Resolution Partners which would make a (gasp) profit from their role in the scheme. The company would handle the transactions and would market the mortgages to investors for resale. Some accounts have talked about the city of San Bernardino filing for bankruptcy because the decrease in property values on average from $370,000 to $150,000 has reduced the amount of taxes flowing to the city’s coffers raising the question of how the mortgages seized would be paid for under eminent domain. However, an issue left mostly unreported will be the impact on the county’s housing market. If the county somehow figured out how to seize the property it would have to pay off the mortgage holder the current value of the house. Presumably since the county is broke, it would have to borrow the money. What investor would lend the county the money if one of its major cities is in bankruptcy? Second, even if it found a source to fund the county’s purchases, what investors would buy them? Any investor would insist on a fairly hefty haircut because the value of the mortgages could still fall from their current value, evoking the possibility of another seizure. This would leave the county on the hook for the difference in what was paid for the mortgages and the price at which they could be sold. Lastly, the impact on the mortgage market in the county would be devastating. Originators would not be able to get the homes underwritten because who would finance them? Mortgage holders would have been forced to take losses on homes whose occupants were current on their payments. The sale of homes would crash, further reducing home prices. Mortgage investors would abandon the market leaving only Fannie Mae and Freddie Mac to buy the mortgages. Yet given the losses being incurred by those GSEs, even their willing participation in this loony scheme would be questionable.