Shortly before the July Fourth holiday, New York City Council members Mark Levine, Daneek Miller, Donovan Richards and Jumaane Williams, joined by New York Communities for Change (NYCC), the Mutual Housing Association of New York (MHANY), myself and other advocates, spoke from the City Hall steps. We urged our city to pursue a solution to its negative equity and home foreclosure crisis that I first began advocating as a federal solution in 2007.
That it is a local solution that multiple cities are now considering makes a certain sense, in view both of the locally concentrated character of the nation’s negative equity problem and of the peculiar paralysis that now grips Washington. But the fact that the cities are taking the lead here is also ironic, in that the solution to which I’m referring is patterned on a plan first introduced by the Frannklin Roosevelt administration during its first months in office — the last time the nation experienced paired stock and real-estate bubbles and busts on an order of magnitude comparable to that which we have recently experienced.
{mosads}When President Roosevelt took office in March 1933, he confronted two complementary crises. One was a massive foreclosure crisis ravaging homeowning families, small family farms and, through them, banks and construction-related industries. A jerry-rigged system of private mortgage finance, which even included an early form of securitization, had helped fuel a real-estate bubble in parallel with the era’s now better-known stock-market bubble.
Like the more recent bubble of the early 2000s, this one relied upon, even while it fueled, continued housing price rises for its continuance. Only under that circumstance would homeowners be able to continue regularly refinancing their loans and thereby avoid having eventually to make impossible payments rooted in short loan terms or ballooning interest rates. When prices ceased rising, therefore, the bubble burst, defaults commenced, prices plunged ever more quickly, and millions of Americans were left owing much more on their homes than their homes were now worth.
Deeply “underwater” loans of this sort default at high rates. (Today the figure is close to 70 percent for the “wettest” loans.) Consequent foreclosures ruin homeowners, harm their neighbors, and do untold damage to communities and housing-related industries. They also harm creditors, in that the expected values of their assets must be discounted by the probability of default and the high costs of foreclosure proceedings (typically at or above $20,000 per home in current dollars).
For this latter reason, many lenders early on in the Great Depression wished to modify underwater mortgages much as many banks today have attempted. But then as now, myriad structural obstacles — some rooted in banks’ obligations to their own creditors, others in our primitive system of private mortgage finance — prevented their doing so. Millions of American families were thus rendered homeless, while lending institutions failed abundantly. The president had to declare a “bank holiday” quickly upon taking office.
But Roosevelt did more. He introduced several new agencies, the descendants of which we still live with, but which we sidelined to our detriment during the most recent housing bubble. These agencies partnered with private investors to purchase underwater loans at fair value from banks, then modified the loans — rescuing creditor, debtor and community alike and even modestly profiting in the process.
I refer to the Homeowners Loan Corporation (HOLC), instituted within three months of Roosevelt’s taking office and later superseded by the Federal Housing Administration (FHA); and the Federal National Mortgage Association (Fannie Mae), later supplemented by the Federal Home Loan Mortgage Corporation (Freddie Mac). After solving the Great Depression’s foreclosure crisis, HOLC, FHA, Fannie and Freddie kept housing markets stable from the mid-1930s to the mid-2000s, and moved us from an under 40 percent to a nearly 70 percent national homeownership rate.
Why, then, our present problems? A return to and proliferation of 1920s-style private mortgage finance in the early 2000s pushed Roosevelt’s agencies aside and brought back ’20s-style bubble and bust. Hence now, as in the early 1930s, creditors can’t write down loans in the numbers required to avert massive and costly foreclosure; private mortgage finance arrangements simply do not permit it. The contracts pursuant to which our most recent bubble-era loans were securitized vest control of the loans not in investors, but in trustees and servicers. And they prohibit these functionaries from modifying the loans in sufficient numbers.
This is why, as I wrote in these pages last May, fully 20 percent of the nation’s outstanding home mortgage loans remain underwater, while another 20 percent have so little positive equity as to be nearly functionally equivalent to underwater loans. It is also why programs like the Home Affordable Modification Program (HAMP), which rely upon incentive payments to loan servicers, were doomed from the start: You cannot bribe servicers into doing what they are contractually barred from doing.
It is precisely for this reason that I began arguing, as it became plain in 2007-09 that we were in for a replay of 1927-29, that FHA (again, HOLC’s successor) begin acquiring, via federal eminent domain authority where necessary, control of underwater mortgage loans that trustees and servicers were no more able to write down than banks had been in the early 1930s. Securitization contracts would have to be sidestepped in order to avert their functioning as mutual suicide pacts among creditors.
There are only two legal authorities through which to do that — bankruptcy and eminent domain. The Obama administration ultimately placed all its chips on the former, seeking “cramdown” legislation in 2009 and 2010. Those efforts failed, and we’re left solely with eminent domain. But the administration seems fearful of revisiting our negative equity problem, meaning that cities have to go it alone.
Will they do so? Yes. Cities from California to New Jersey are actively contemplating the eminent domain plan, with some poised already to act on it. And now the latest city to consider the plan might well be the largest — New York. As a new report issued by the aforementioned NYCC and MHANY demonstrates, some 60,000 New York City homeowner families — disproportionately families of color — are in crisis stemming from post-bust negative equity. Literally billions of dollars accordingly stand to be lost by those families, their creditors and their communities.
The city in consequence has very good reason to partner with current bondholders, HOLC-style, and employ its eminent domain authority to purchase underwater mortgage loans out of the private-label securitized trusts in which they are locked, modify the loans much as Roosevelt’s HOLC did, and thereby rescue homeowners, its own ravaged communities, its tax base and the bondholders themselves — who, as bankers back in the ’30s, can’t do the write downs themselves.
For New York and other cities — and especially for black and Latino communities therein — to speak of a national “housing recovery” is just a bad joke. By solving their own negative equity and foreclosure crises, New York and other cities will themselves bring that national recovery which the national government seems thus far unable to do.
Hockett is a professor of law at Cornell University Law School.