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Originally published August 17, 2012 at 10:24 PM | Page modified August 18, 2012 at 12:22 PM

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Governments consider seizing underwater home mortgages

Data shows fewer underwater mortgages are defaulting, and that may cool action by cities and counties to use the power of eminent domain to flush out bad mortgages and move empty properties along.

Bloomberg News

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Local governments from New York to California are increasingly considering plans to seize mortgages to protect their housing markets against homeowners abandoning properties with values below what they owe.

They may be a year too late. Data on the loans municipalities are being advised to target show fewer underwater mortgages are defaulting and when borrowers stop paying, modifications increasingly include balance cuts. The number of Americans with negative equity is also falling as housing recovers from its worst slump since the 1930s, Chris Katopis, head of the Association of Mortgage Investors, said this week at hearing held by a Chicago City Council panel.

A group of officials formed to weigh the strategy in San Bernardino County, Calif., met Friday for a second time to discuss using eminent domain, whose advocates include Yale University's Robert Shiller and actor John Cusack, who attended the Chicago hearing. They're sparring with bondholders such as Pacific Investment Management Co. (Pimco), banks and real-estate firms.

Cusack, the Evanston, Ill.-raised actor who starred in "Say Anything" and "Grosse Pointe Blank," said in an Aug. 13 video interview with the Huffington Post that it's "a question of fundamental fairness" for homeowners as federal officials fail to act aggressively enough, and would "help reset the markets."

The initiative is being pitched to communities across the U.S. by Mortgage Resolution Partners, which says loans held by bonds without government backing should be targeted. The San Francisco-based company is seeking to profit from managing parts of the process.

Buying up mortgages

Its proposal involves governments forcefully buying nondelinquent mortgages for less than what borrowers owe. Homeowners could then be refinanced into smaller, federally backed loans. Using eminent domain is justified because stabilizing housing and reducing vacant properties is in the public interest, and bondholders would receive cash deemed to be the fair value of their loans, the firm says.

"It might have been the reasonable thing to do in the teeth of the crisis," said Mark Zandi, the chief economist at Moody's Analytics who this week advocated with Nobel Laureate Joseph Stiglitz for federal legislation to aid underwater homeowners.

"The risks are much less significant today," meaning policymakers should avoid "breaking contracts" and potentially damaging lending, he said.

Underwater homeowners remain a threat to housing, including those who continue to pay, according to Mortgage Resolution Partners President Steven Gluckstern, a former senior insurance executive including at the reinsurance operations at Warren Buffett's Berkshire Hathaway.

"Eventually, they all stop," Gluckstern said. "There will be no recovery until this problem has been addressed."

Money managers AllianceBernstein and Western Asset Management and groups that lobby for banks including the Housing Policy Council and real-estate firms such as the National Association of Home Builders say seizing loans isn't an appropriate response.

"Nail in the coffin"

Scott Simon, the mortgage head at Pimco, which runs the world's largest bond fund, has said it would be a "nail in the coffin" for the private mortgage market.

Chicago Mayor Rahm Emanuel, the former chief of staff to Obama, also said Aug. 14 that he doesn't "think it's the right way to address the problem," the Chicago Tribune reported.

Shiller, the Yale economics professor who warned of a housing bubble in the 2005 edition of his book "Irrational Exuberance," has supported the idea.

He wrote in a June 23 op-ed in The New York Times that, "We have to stop the wishful thinking that the problem will solve itself through a spontaneous rally in home prices."

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