A Housing Crisis Solution Sure to Panic Wall Street

There is no better illustration of the disconnect between our economy's winners and losers than the California real estate market. The winners are bidding up Silicon Valley home prices and resurrecting the house-flipping craze. The losers are just trying to hold their cities together under a wave of mortgage defaults. Is there a solution?

Yes: strict socialism. But until that idea grabs America's imagination, a slightly (but only slightly) less jarring solution is about to be rolled out in Richmond, California, a typical not-economically-winning city that is suffering from a huge swath of underwater homeowners. The NYT reports today that Richmond may be ready to pull the trigger on a possible housing crisis solution that has been floating around for quite some time, but that has always been considered too radical to actually try: using the power of eminent domain to buy underwater mortgages, in order to help homeowners avoid foreclosure. From the NYT:

The city is offering to buy the loans at what it considers the fair market value. In a hypothetical example, a home mortgaged for $400,000 is now worth $200,000. The city plans to buy the loan for $160,000, or about 80 percent of the value of the home, a discount that factors in the risk of default.

Then, the city would write down the debt to $190,000 and allow the homeowner to refinance at the new amount, probably through a government program. The $30,000 difference goes to the city, the investors who put up the money to buy the loan, closing costs and M.R.P. The homeowner would go from owing twice what the home is worth to having $10,000 in equity.

This is not a purely public-spirited affair; it is a capitalist solution to a capitalist problem. The firm, Mortgage Resolution Partners, that is assisting Richmond is doing this for profit. And if it catches on, they could potentially access an entire nation worth of bad loans. The city uses the threat of eminent domain as the stick behind the carrot of its offer to buy the loans at current value. The original owners of those loans take a haircut. MRP gets a profit. The homeowners are saved, more or less, and the city gets the general benefit of not having its neighborhoods fall completely apart.

The financial world is, of course, strongly opposed to this tactic, because if it ever went into widespread use it could cost the people who invested in all of these shitty, bubble-inflated housing loans tens or hundreds of billions of dollars. The political backlash against cities could be severe. And the wanton use of eminent domain is something that should always be approached with caution. But desperate times call for desperate measures, and all that. A glut of empty foreclosed homes and a glut of poor homeless people at the same time just doesn't make sense. Besides, this is how capitalism works. Even the winners have to lose sometimes.

[Photo: Gail Williams/ Flickr]