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Why Mel Watt tacitly approves using eminent domain on mortgages

Mel Watt's nomination will impact mortgage REITs and originators (Part 4 of 5)

(Continued from Part 3)

The eminent domain issue

On this issue, Watt gained himself no fans on the other side of the aisle. Eminent domain has been a highly controversial and contentious issue that’s been proposed but not enacted. Essentially, a locality would pass a law allowing the local government to seize underwater mortgages, pay the investor “fair value,” and then cut principal and refinance the loan. The locality would partner with a hedge fund. And for the hedge fund to make a return, the first investor must be paid less than fair value (or the value of the property). While eminent domain has been used to take property (typically in the case of constructing something like an expressway or an airport), this is the first instance of a government using eminent domain to take a security away from an investor.

The Security Industry and Financial Markets Association (SIFMA) issued a strong statement saying that any mortgages originated in areas that have passed eminent domain legislation would be ineligible for TBA trading, which would make the loans unsecuritizable and effectively cut off credit to that locality.

Mel Watt was asked about the eminent domain issue and basically took a pass, saying he would defer to state and local governments considering the idea, which was interpreted as a tacit approval of the strategy.

Reformation of the GSEs (government-sponsored enterprises)

Mel Watt supported ending Fannie and Freddie as we know it, and reducing the government’s footprint in the housing sector. The idea would be to replace Fannie and Fred with a government re-insurer, called the Federal Mortgage Insurance Commission, which would bear all losses after 10%. The first 10% losses would either be borne by a private insurer, or would be covered through overcollateralization. Of course, we’re way early in the process of reforming the GSEs, and any solution will undoubtedly come after 2014.

While Watt would probably change the mission of Fannie Mae and Freddie Mac, he will ensure that the GSEs continue to promote low-income lending. Watt is a Community Reinvestment Act guy to the bone.

Senators Bob Corker and Mark Warner (D-VA) just released their plan on how to deal with the GSEs. There’s a lot of work to do, and part of it will rely on guidance from the Consumer Financial Protection Bureau. But it seems everyone agrees that the government must reduce its footprint in the mortgage market, for at the moment, the mortgage market’s almost nationalized.

Continue to Part 5

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