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Sunday, July 15, 2012

Eminent Domain and Sanctity of Contract: Mortgage-Relief as “Dangerous”


With about half of the mortgages “under water” (i.e., being more than the houses are worth in terms of market value), government officials in San Bernardino County floated a proposal in 2012 to use California’s sovereign power of eminent domain to buy up the mortgages, cut them to the current value of the homes, and resell the mortgages to a private investment firm, which would allow the homeowners to lower their monthly payments and stay in their homes. The New York Times labels this a “drastic option,” coming from a government that was “(d)esperate for a way out of a housing collapse that has crippled the region.” This characterization of the proposal as “radical” fits with the bankers’ financial interest and perspective. In actuality, eminent domain is typically understood to be a basic power of government.

Doubtless the amounts that the government would pay as it exercises its right of eminent domain would not be satisfactory to the bankers holding the mortgages, for the “mere idea . . . rankled” the bankers, whose leaders claimed that it would set “a dangerous precedent of allowing a government entity to act as a lender and would discourage banks from loans in the area.” The danger may be in the eye of the beholder, particularly if he or she is accustomed to exacting the sanctity of contract as if not even a government could touch it. In other words, the exaggerated response may reflect the mistaken belief that eminent domain is somehow illegitimate for a government. This belief is reflected in the expectation of Ken Bentsen, an official of the Securities Industry and Financial Markets Association, that the proposal would almost certainly be challenged in court.

“If the government has the ability to abrogate the contract at will and at the expense of the bond holder, the investor is going to do one of two things: require a tremendous premium for the risk they are incurring, or just not invest at all,” Ken Bentsen said. “It would be a risk factor that would be impossible to underwrite.” Government does have the right to abrogate or nullify a contract “at will.” It is not as though government were merely a business; governmental sovereignty does not apply to the private sector, yet this does not detract from government’s distinctive role in society. Furthermore, the claim that lending would dry up without a huge risk premium assumes that other governments would not follow suit and that the banks would otherwise be able to enforce the sanctity of the contracts against borrowers under water.

In fact, the bankers’ insistence to have it all their way may have set them up to get far less. Greg Devereaux, San Bernardino County’s chief executive, expressed frustration with the level of the bankers’ opposition to the plan. “If they want to come and talk and propose other solutions, great, but that’s not what is happening. Instead they are just trying to kill it because they have nothing but their own interest in mind.” He has hit on the crux of the problem. Having nothing but their own financial interest in mind, the bankers had opposed even an amendment submitted by Dick Durbin of Illinois that would have permitted bankruptcy judges to modify mortgages.

Under the mistaken belief that sanctity of contract transcends even governmental sovereignty as if under natural law (but not that which prohibits usury!), the bankers applied “drastic” and “dangerous” to the “usurpation at will” by eminent domain, as if it were suspect or at the very least sordid in nature. In actuality, it is the bankers’ insistence on having it all their way that is squalid and ultimately self-defeating. The government’s invoking of eminent domain can be viewed as a reaction to the bankers’ self-defeating rigidity or stubborn selfishness.

Preferring foreclosure to adjusting mortgages that are under water (i.e., remaining book value over the market value of the property), the bankers were sitting ducks for any government official aware of the nature of governmental sovereignty as not being constrained by sanctity of contract. While excessive use of such sovereignty would doubtless detract from parties otherwise willing to enter into a contract, San Bernardino’s plan was hardly over-encompassing or capricious. Indeed, the limitation that the mortgage borrower must be current on payments is a self-defeating and unnecessary limitation imposed by the government on its own plan. Borrowers most in need should not be eliminated at the outset; rather, they should be encouraged to take part, and this would not cause future lending to somehow collapse without customers having to be gauged by banks under the pretense of a “risk premium.”

In short, government’s use of eminent domain is fitting and proper in protecting bank customers from unreasonable bankers in line with the public interest that people not be thrown out of their houses. It is not as if a government were somehow a peer or even a rival of a bank. Rather, government is tasked with providing a floor such that no one faction in society extracts too much from another segment, even if in line with a contract. Government can so act “at will.” The permission of banks is not required, or frankly even helpful, in the workings of governmental sovereignty.

The bankers seem to have been presuming that they themselves, as guardians of the sanctity of contract, are sovereign or at least just as sovereign as governments are. If so, the danger lies in permitting those self-interested associations a role in their capacities as entities distinct from their members in lobbying government officials or regulators even and especially on matters touching on the entities’ respective financial interests. The danger includes distortion and hyperbole rather than greater insight for policy-makers.

It would be sad indeed were the plan of the government of San Bernardino county (i.e., the sovereignty of that government, which is ultimately that of the Republic of California) finally dependent on the financial/political power of the investment company participating as a “middle man” in the plan, specifically in countering the financial/lobbying power of the banks. That is to say, the sovereignty of governments being used in the public good should not have to depend on a particular result of the “invisible hand” of private self-interests as if sovereignty were a market-based outcome of lobbying.

Source:

Jennifer Medina, “California County Weighs Drastic Plan to Aid Homeowners,” The New York Times, July 14, 2012. http://www.nytimes.com/2012/07/15/us/a-county-considers-rescue-of-underwater-homes.html?pagewanted=1&ref=business

See: Cases of Unethical Business: A Malignant Mentality of Mendacity, available in print and as an ebook at Amazon.