‘Seizures May Be Cities’ Last Hope in Mortgage Crisis’

Amir Sufi of the University of Chicago Booth School of Business:

Seizures May Be Cities’ Last Hope in Mortgage Crisis, by Amir Sufi, Commentary, Bloomberg: The failure to address crippling household-debt burdens is leading local governments to embrace the radical idea of using eminent domain to seize and write down mortgages.

Over the past month, two cities in California — Stockton and San Bernardino — have made moves to file for bankruptcy. … The San Bernardino and Stockton episodes are representative of a national crisis: Crippling household-debt burdens and foreclosures have been dragging down the economy for the past five years. Renegotiation of underwater mortgages by the private sector has been almost nonexistent. Despite strong evidence that frictions related to securitized mortgages are preventing the efficient restructuring of household-debt burdens, policy makers have largely sat on the sidelines.

With local governments feeling directly threatened, some cities have put forth a bold solution: Governments should use eminent-domain powers to buy mortgages, impose losses on bondholders, and write down principal amounts owed by the borrower. The argument is pretty simple: Debt burdens and foreclosures are crushing our cities; private lenders are showing no willingness to renegotiate; and there are no meaningful attempts at the federal level to help. San Bernardino and Stockton are Exhibits A and B.

Using eminent domain to impose losses on bondholders is unquestionably a radical idea. … There comes a point, however, when it becomes impossible to impose further losses on debtors. And when that happens, creditors are expected to take losses on their positions. This is exactly why restructuring debt contracts is a valuable and important part of the financial system. In corporations and commercial real estate, such restructuring happens every day.

But this isn’t happening in mortgage markets. … Bondholders and other creditors are understandably furious at the violation of private contracts implied by the eminent- domain proposals. They shouldn’t be surprised, though. Everyone has a breaking point. Proposals to write down debt will become even more radical unless the private sector shows a greater willingness to renegotiate mortgages.

I hope we have learned a point I’ve tried to make again and again here, that helping households with their balance sheet problems is essential in curing a balance sheet recession. Banks got plenty of help with their balance sheet problems based upon the “too big to fail” argument, but households didn’t get as much attention. Collectively, households are too big to fail as well, but we let them fail anyway and are now paying a much higher cost than if we’d done more to address household balance sheet problems early in the recession.

[See here for a recent link/discussion to additional research from Mian and Sufi on What Explains High Unemployment? The Aggregate Demand Channel.]

This post originally appeared at Economist’s View and is posted with permission.

2 Responses to "‘Seizures May Be Cities’ Last Hope in Mortgage Crisis’"

  1. paul   July 20, 2012 at 10:36 am

    I agree there needs to be an across the board debt restructuring for US households, however, this cockamamie proposal is the most ripe for abuse and further fraud and scandal that I have heard of yet. My corrupt local village has been scamming millions of dollars a year from their TIF Districts and have already coupled it with Eminent Domain abuse. Giving local communities this power is just another deferred disaster in the making.

  2. Kat Marcelo   August 30, 2012 at 8:51 pm

    I find this as a very complex and risky solution for cities to undertake. Bankrupt cities cannot even address concerns regarding teacher mortgage and exit debts.