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Will eminent domain ruin the mortgage market?

Think Tank
Raphael Bostic,
Director of the Bedrosian Center on Governance at the University of Southern California
Previously Assistant Secretary for Policy Development and Research at the U.S. Department of Housing and Urban Development
Richard Green,
Director of the Lusk Center of Real Estate at the University of Southern California
Previously Chair of Real Estate Finance at The George Washington University School of Business
Peter Muoio,
Managing Director at Auction.com
Senior Principal of Maximus Advisors with over 25 years of experience in real estate research

This is the third installment of HSH.com’s Think Tank series which features in-depth question and answers from the nation’s top real estate professors and professionals.

Thanks to mortgage rates near record lows and federal programs designed to target underwater borrowers, millions of American homeowners have refinanced their home loans to help reduce their mortgage costs.

However, not everyone has been able to qualify for these programs, leaving some communities with thousands of properties that are worth less than their mortgages. Some cities in the U.S. are taking a somewhat radical approach to refinance these underwater mortgages: eminent domain.

So far, Richmond, Calif., is the only city on the cusp of seizing private properties in order to refinance them.

We asked Raphael Bostic, Ph.D., director of the Bedrosian Center on Governance at the University of Southern California, Richard Green, Ph.D., director of the Lusk Center of Real Estate at the University of Southern California, and Peter Muoio, Ph.D., Managing Director at Auction.com to offer their perspectives on what impact refinancing mortgages through eminent domain will have on the U.S. mortgage market.

Q: Some cities are trying to claim eminent domain to refinance underwater mortgages. How is this use of taxpayer money going to affect U.S. mortgage markets?
Raphael Bostic, Ph.D.
Director of the Bedrosian Center on Governance at the University of Southern California

A: Since this isn’t happening everywhere, it’s not a market-wide issue. I expect this to only affect a few very specific locations. However, if more cities respond to failing loans by claiming eminent domain, we’ll have to see how banks respond. Access to capital could dry up. It could cause banks to increase borrowing costs by instituting a premium to do business in a risky area. You can bet regulators will be studying this issue closely.

Richard Green, Ph.D.
Director of the Lusk Center of Real Estate at the University of Southern California

A: Richmond, Calif., is the only place doing this. If this is only happening in Richmond, it’s not a big deal for everyone else. Other places are threatening eminent domain because they’re tired of lender behavior. But Richmond is the only city currently claiming eminent domain. If this does grow into a larger issue across more areas, it will ultimately show up in the cost of mortgage lending. Underwriting will grow tighter, costs will rise and there will be an overall pullback in lending.

Peter Muoio, Ph.D.
Managing Director at Auction.com

A: Right now, there aren’t enough cities actually claiming eminent domain to refinance underwater mortgages to have any impact. Some places are considering it, but only Richmond, Calif., is threatening it. What this does do is create a cloud of uncertainty. You could envision lenders avoiding these areas or increasing costs where this is (hypothetically) happening, and thus reducing availability for borrowers. So, as where cities think they’re doing good by refinancing these troubled properties, their efforts could backfire and it could have a perverse effect. Whether it’s fees, points or interest rates, there could be a cost increase for borrowers in these areas to compensate for the lender’s risk, lowering mortgage availability in that community.

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