Category Economic Policy

Eminent Domain is Coming to Richmond, CA

Danny Vinik 4 Comments

After quite a bit of searching, Mortgage Resolution Partners (MRP) has finally found a town willing to take a chance on its plan to use eminent domain to help underwater homeowners. The details for this specific plan aren’t quite clear yet, but this plan still has a major problem. Let’s first look at how this will work.

Richmond is giving investors a choice: either willingly sell or we’ll use eminent domain to force you to sell. According to the New York Times, the city is offering to pay what it deems to be fair market value:

The city is offering to buy the loans at what it considers the fair market value. In a hypothetical example, a home mortgaged for $400,000 is now worth $200,000. The city plans to buy the loan for $160,000, or about 80 percent of the value of the home, a discount that factors in the risk of default.

MRP’s plan has been to put up the capital for these purchases so that no taxpayer money is involved. After it has purchased the loan – either by agreement or by force – the city will write down the value of the loan so that the homeowner is no longer underwater and can refinance at lower rates:

Then, the city would write down the debt to $190,000 and allow the homeowner to refinance at the new amount, probably through a government program. The $30,000 difference goes to the city, the investors who put up the money to buy the loan, closing costs and M.R.P. The homeowner would go from owing twice what the home is worth to having $10,000 in equity.

Done correctly, using eminent domain to purchase underwater homes is a promising idea. Unfortunately, MRP’s plan has always been aimed at helping investors make a nice profit, not helping out homeowners. This plan has the same major flaw: it doesn’t just write down loans for homeowners delinquent on their loans, but also for borrowers current on them.

The intellectual godfather of the plan, Cornell professor Robert Hockett, noted in his paper promoting the plan that MRP would only contribute capital to use eminent domain for mortgages that are current. The problem with this is that these are the homeowners who don’t need help. Yes, they are severely underwater and would be helped by a principal write down, but they aren’t defaulting on their loans. They are still able to make their payments.

Of course, for that reason, those borrowers are also the most valuable for investors. Homeowners current on mortgage payments on a $400,000 loan that is for a house worth only $200,000 is still profitable. The security is no longer worth face value since the losses in the case of default are now higher due to the lower home value. But that means the loan is worth somewhere between $200,000 and $400,000, depending on the risk of default. Since the home is worth $200,000 now, the loan is worth more than 100% fair value of the home.

MRP’s original plan was to only use eminent domain for homeowners current on their mortgages and would not pay anything more than 85% the fair market value of the home. As just shown, these loans are worth more than 100% the value of the home. No investor would ever be willing to sell at this price, even if it could solve the collective action problem that permeates the housing market (more on this later today).

However, this is the only way MRP makes money. If it were to purchase the loan for $250,000 (as it may be worth) and then refinance it at $200,000, it would lose money on the transaction. The only reason that the company earns a profit is because it’s using eminent domain to pay significantly less than the fair value of the loan.

Banks are (rightfully) furious at Richmond’s plan and will undoubtedly take this to court, arguing that the proposal is unconstitutional in a number of ways. Not least of all is the fact that eminent domain requires the city to pay fair market value for property. In purchasing the mortgages of homeowners who are current on their loans, Richmond is certainly not adhering to that rule. What really sucks for the city is that banks will likely freeze credit in the area as both a punishment and a deterrent to warn other cities not to follow in Richmond’s footsteps. Maybe more details will emerge that make this plan look like a better deal, but right now it’s looking like MRP finally duped a municipality into implementing its plan and Richmond is going to face severe consequences for doing so.

Have Fed Chair Odds Really Changed?

Danny Vinik 2 Comments

First, current Federal Reserve Vice-President Janet Yellen was President Obama’s likely selection to take over for Ben Bernanke when his term expires next year.

Then, Ezra Klein reported that the race was between Yellen and Larry Summers with Summers the current odds-on favorite.

Then, Senate Democrats revolted and the liberal blogosphere exploded against Summers.

Last Friday, Klein posited that a dark horse candidate could emerge, such as Roger Ferguson.

Let’s take a moment to calm down, ignore “inside sources,” and look at what has really changed over the past couple of weeks.

1. Liberals are as hardened as ever against Summers
2. Summers’s few statements on monetary policy indicate he’d be more hawkish than Yellen.
3. WSJ analysis showed that Yellen’s economic predictions have been correct more than anyone else’s at the FOMC.
4. Wall Street overwhelmingly wants Yellen over Summers.

Numbers 1, 3 and 4 there overwhelmingly favor a Yellen selection. For most liberals, number 2 would also work in Yellen’s favor, but Obama’s recent interview with the New York Times indicates that he’s still concerned about inflation and may want a more hawkish Fed Chair, as Summers would be.

So, given all that, how can Yellen not be the favorite? Klein is well-connected within the Administration and if anyone had an inkling on which direction Obama was leaning, it’d be him. But it’s worth remembering how secretive this selection is. Here’s Wonkblog’s Neil Irwin just a few weeks ago:

The most important thing to know at this stage is this: The people who know aren’t talking, and the people who are talking don’t know.

For a decision of this much importance and sensitivity, the president is likely to rely on a very small number of senior advisers to come up with a short list of candidates and advise him on their strengths and weaknesses. For the Fed chairmanship, the process is reportedly being led by treasury secretary Jack Lew, and likely also includes Denis McDonough, the chief of staff. It probably includes Gene Sperling, the top economic adviser in the White House, and possibly Jason Furman, who has been nominated to lead the Council of Economic Advisers. Perhaps a close Obama adviser like Valerie Jarrett gets a seat at the table, and somebody from the ever-discreet presidential personnel office in the White House.

Whoever makes that exact list, those are the only people who actually know the state of play on the decision — who’s up, who’s down, what attributes the president really cares about. The details of the decision-making will remain closely held even within the White House until an announcement is imminent. And those on that short list of people actually in the know will reliably clam up and reveal absolutely nothing when the topic comes up, whether it is with a former colleague outside government or a reporter, even when off the record.

Former White House economic adviser Jared Bernstein said the same thing last week:

No one knows who it will be.  Sure, there’s a short list and Summers and Yellen top it–btw, I wrote those names in no other order than alphabetical.  I would very heavily discount anything you read that says anything much more than what I’ve just told you.

I’m actually a bit surprised to see Klein buying into all of this back-and-forth about who’s leading the race. Maybe he has great sources or the Administration was using him to see potential reaction to choosing Summers. Either way, the developments over the past few weeks would seem to increase the chances of Obama choosing Yellen, not hurt them. Will Yellen be the eventual selection? Maybe. Maybe not. We’re not going to know for a while. But don’t discount her because a few rumors hint at the President leaning in a different direction. The fundamentals still point to her and if anything, have only improved over the past few weeks. She’s still the odds-on favorite to be the next Fed Chair.

The CFPB Has Adequate Checks

Danny Vinik Leave a comment

As a fan of the Consumer Financial Protection Bureau (CFPB), I am very happy that Richard Cordray will almost certainly be confirmed as its legitmate head later this evening. It took Majority Leader Harry Reid (D-NV) almost deploying the nuclear option in the Senate, but it appears that Cordray’s nomination will overcome a filibuster and that he will be confirmed as the agency’s first director.

So, why did it take so long for his confirmation? Not because he isn’t qualified. Republicans have no qualms about his qualifications. What Republicans have objected to is the agency itself. A letter to President  Obama on February 1st this year signed by 43 Republicans outlined their concerns. They are as follows:

  1. Establish a bipartisan board of directors to oversee the Consumer Financial Protection Bureau
    .
  2. Subject the Bureau to the annual appropriations process, similar to other federal regulators
    .
  3. Establish a safety-and-soundness check for the prudential regulators

After today’s vote to proceed to his nomination, Senator Chuck Grassley (R-IA) complained that “we don’t have adequate checks within the bureaucracy.”

Well, the last few days demonstrate why Dodd-Frank created a single director for the agency and not a board. Just look at the National Labor Relations Board (NLRB). The Board currently has just three members and on August 27, when Mark Pearce’s term expires, it will be unable to hold a quorum and thus will have no power. Without Reid’s willingness to invoke the nuclear option, the GOP would have continued filibustering all NLRB nominees, effectively rendering the agency useless. Is that what Democrats want to see happen to the CFPB? Of course not!

Having a board of directors instead of a single director has its own advantages. More voices at the top of the agency can prevent it from acting outside its purview or not enforcing strict enough regulations. But it also slows the agency down with more people at the top. It would also require multiple confirmations to function. The GOP could confirm a couple of nominations and just filibuster the rest to prevent the agency from operating. As of today, that should be a thing of the past with the agreement between the two parties never to filibuster executive nominations again. But up until today, Democrats did not just fear that the GOP would obstruct the agency this way; they knew it would. Republicans can appeal to change it now that there is an agreement on filibusters, but they still must demonstrate why a board is better than a single director for the CFPB.

The CFPB also has to report on its actions and appear before Congress. It is subject to an annual audit by the Government Accountability Organization (GAO). It’s also monitored by the Inspector General for the Federal Reserve Board of Governors. Republicans want a dedicated Inspector General for the agency. Fine by me. I’m not sure why Democrats blocked the amendment earlier this year, possibly out of anger over Republication obstructionism over Cordray. Now that he’s confirmed, Democrats should relent and allow the agency to have its own IG.

How about subjecting the budget to the annual appropriations process? This one is easy: Hell No! Republicans’ favorite way to prevent agencies from using their full powers is to reduce or eliminate their funding. House Republicans have repeatedly voted to slash the Commodity Futures Trading Commission’s (CFTC) budget even as the agency has taken on a greater regulatory role after the passage of Dodd-Frank. The Securities and Exchange Commission (SEC) has seen its budget cut as well. Neither agency has near enough money to compete with the seemingly endless cash from Wall Street. Why would Democrats allow the same thing to happen to the CFPB? The agency receives a maximum of 12% of the Federal Reserve budget. It’s not unlimited and if it wants more funding, then it must ask Congress for it.

As for the safety-and-soundness check, Mike Konczal explains it better than me:

There is already a safety-and-soundness check at the OCC, which, through the Financial Stability Oversight Council, can vote on vetoing CFPB actions. It’s not clear why this is important to Republicans. A cynical reading would be that since profit-making is one way to achieve the safety and soundness of banks that the CFPB regulates, anything that might get in the way of banks ripping off their customers would hurt safety and soundness. And, indeed, big fines and settlements for illegal practices do, in theory, mean more capital that they’ll have to raise, or lower earnings for shareholders. But aren’t such fines and settlements how we provide accountability to the financial sector?

The FSOC can veto any CFPB action if it endangers the “safety and soundness of the United States banking system or the stability of the financial system of the United States.” That’s a pretty good safety-and-soundness check. If Republicans really want to interpret such a check so that any rule cannot reduce the profits of banks, that’s ludicrous. Otherwise, I’m not sure what they want. The Bureau must already “consult with prudential and other federal regulators during rulemaking regarding prudential, market and systemic objectives.”

So, it’s a happy day for CFPB-lovers out there. The agency will finally have a legitimate head without giving into Republican demands. Democrats should agree to install a dedicated IG for the Bureau and let the agency function as it was designed from here on out. It’s about time it had its full powers.