CORNE LAW SCHOO ELL W OL

LEGAL STUD RESEARC PAP SE L DIES E CH PER ERIES

It Take a Vil es llage: Municip Con M pal ndemna ation Pr roceedi ings and Publi ic/Priva Par ate rtnersh for hips Mo ortgage Loan Modifi e ication, Value Preser , e rvation, d omic R Recovery y and Econo
Robert C. Hoc t ckett Cornell Law Sc l chool Myron Taylor Hall n It thaca, NY 14853 N 3-4901
Cornell Law Schoo research p l ol paper No. 12 2-12

This pa aper can be dow wnloaded with hout charge from: The Social Sci ience Research Network Elec h ctronic Paper C Collection: http://ssrn.com/abstract=2 038029

MemorandumofLawandFinance

BreakingtheMortgageDebtImpasse:MunicipalCondemnationProceedingsand Public/PrivatePartnershipsforMortgageLoanModification,ValuePreservation, andLocalEconomicRecovery

RobertHockett*

Introduction:ItTakesaVillage Sixyearsafterresidentialrealestatepricespeakedandthenplunged,U.S.primaryand secondarymortgagemarketscontinuetolanguishinselfworseningslump.1Asthemodifying phraseselfworseningsuggests,feedbackeffectsconstituteacriticalcomponentbothofthe problemandofitsstubbornpersistence.2Theseeffectsoperatebothasbetweenproperty pricesandmortgagedefaultrates,andasbetweenprimaryandsecondarymortgagemarkets andbroaderlocalandregionaleconomies.3 Asithappens,thementionedfeedbackloopsarethemselvescriticallymediatedthrough uncoordinatedmarketdecisionstakenbymultipleactorswhofaceformidablecollectiveaction hurdleshurdlesthatcanpreventforwardorhastenbackwardmovementbyendowing individualexpectationswithsignificantselffulfillingprophecyproperties.4Theselatterare thesourceoftheaforementionedfeedbackeffectseffectsthatcanamplifyoptimisminto dysfunctionalbubbleorboom,andpessimismintobustandprotracteddepression.5

ProfessorofLaw,CornellLawSchool;Fellow,TheCenturyFoundation.ParticularthankstoGreg Alexander,MikeCampbell,NestorDavidson,MikeDorf,BobFrank,BillFrey,HowellJackson,BobLitan,Lynn Lopucki,EduardoPealver,BobShiller,DavidSkeel,LynnStout,JoeTracey,andLauraUnderkuffler.Specialthanks toSauleOmarova.Lastandanythingbutleast,thankstomyfrequentcollaboratorDanielAlpert.Thanksaswellto myother,unnamedcolleaguesatCornell,TCF,andotherinstitutions.Opinionsexpressedhereinarethoseofthe authorandnotproperlyattributabletohisaffiliatesabsentexpressconfirmation.Indeedtherearedifferenceson somepointsbetweensomeofthoseherenamedandtheauthor.Readersshouldalsobeadvisedthattheauthoris disinterestedinwhatheishererecommending,butmaysubsequentlyundertakemorelegal,financialor expositoryworkinconnectionwiththeproposalsofferedandadvocatedherein. Tellingstatisticsaresuppliedinabundancebelow,SectionII. 1 Thestructuraldynamicsarelaidoutbelow,SectionsIandII. 2 Id.Mortgagemarketscausallyinteractwiththebroadereconomywithparticularforcebecausehomes 3 aretheprincipalformthatwealthtakesamongthatbroadAmericanmiddleclassuponwhosehealthyconsumer expenditurebotheconomicgrowthandemploymentdepend.SeeRobertHockett,SixYearsOnandStillCounting: SiftingThroughtheMortgageMess,9HAST.BUS.L.J.__(2012)(forthcoming).Moreagain,infra,SectionsIandII. Classiccasesinpointarebankruns(beforedepositinsurance),hyperinflations,andliquiditytraps.See 4 againinfra,SectionsIandII.AlsoRobertHockett,RecursiveCollectiveActionProblems,5J.APP.ECON.__(2012). Theonetypicallyfollowstheother,withassetssymmetricallyundervaluedbyuncoordinatedmarkets 5 duringbustsjustastheyhavebeenpreviouslyovervaluedbyuncoordinatedmarketsduringantecedentbooms. SeeHockett,id.;alsoRobertHockett,AFixerUpperforFinance,87WASH.U.L.REV.1213(2010).
*

 Becausethehallmarkofsuchrecursivecollectiveactionproblems,asweshallhere callthem,istheiraggregatingmultipleindividuallyrationaldecisionsintocollectivelyself defeatingandevenselfworseningoutcomes,6theirsolutionrequiresthepresenceofa collectiveagentempoweredtoactonbehalfofallpartiestooptimizejointoutcomes.7 Againstthisstructuralbackdrop,someacuteobservershavecometorecognizethat somesuchcollectiveagentwillberequiredtosolvethatcollectiveactionchallengewhichlies attheheartofthatselfworseningslumpwhichcontinuestoafflictU.S.localandregional mortgagemarketsand,throughthem,ourlocal,regional,andhencenationaleconomies.8 Thequestionis,whatpersonorentityisbestsituatedtodischargethiscriticalfunction? Foranumberofreasonscomprehensivelyelaboratedbelow,9manythoughnotallof themrootedintheinherentlystatecenteredcharacterofcontract,commercial,trustandreal propertylawunderourconstitutionalorder,10thefederalgovernmentanditsinstrumentalities arenotnowwellsuitedtothistask.11Atbesttheyarebutcomplementarilysituated.
6 Seeagaininfra,SectionII.ThetermrecursivecollectiveactionproblemisintroducedinRobertHockett, BrettonWoods1.0:AnEssayinConstructiveRetrieval,16N.Y.U.J.LEGIS.&PUBLICPOLY__(2012)(forthcoming). AlsoHockett,RecursiveCollectiveActionProblems,J.APP.ECON.,supranote4.Theseproblemsdefiningfeatureis theirspiralingtendencyupward(asininflations)ordownward(asinbankrunsandslumps)asrootedin uncoordinated,selffulfillinglypropheticindividualdecisions.More,again,infra,SectionII. Seesourcescitedsupra,notes4through6.Thiswillalsobeanaptplacetonotethatweshalloftenlump 7 coordinationandcollectiveactionchallengestogether,notwithstandingtheirsubtledistinctions.Wedoso partlyforreasonsofsimplificationthatdoesnoharminthepresentcontext,andpartlybecausecollectiveagents addressbothkindsofchallenge. See,e.g.,FederalReserveBoard,TheU.S.HousingMarket:CurrentConditionsandPolicyConsiderations, 8 WhitePaper,January4,2012,at3;andWilliamC.Dudley,HousingandtheEconomicRecovery,Remarksatthe NewJerseyBankersAssociationEconomicForum,January6,2012,availableat http://www.newyorkfed.org/newsevents/speeches/2012/dud120106.html. 9 Seeagaininfra,SectionII. Seeinfra,SectionIV,formoreonourstatecenteredfederalsystemandthereservationofcontract, 10 commercial,andespeciallytrustandrealpropertylawtothestatespursuantthereto. InadditiontoSectionIV,SectionII,inwhichthefailuresoftheFHFA,theGSEs,HAMPandHARPare 11 explained,isgermanetothispoint.IhastentonoteherethatHowellJacksonproposedaresolutiontothecrisis usingTarpmoneysandeminentdomainauthorityasearlyas2008.SeeHowellE.Jackson,BuildaBetterBailout, CHRISTIANSCIENCEMONITOR,September25,2008,availableat http://www.csmonitor.com/Commentary/Opinion/2008/0925/p09s02coop.html. TheauthorofthisMemorandumproposedsomethingsimilar,inthiscaseemployingTARPmoneysto fundFHApurchasesofvoluntarilyrelinquishedtroubledmortgages,whichhesuggestedwouldbeforthcomingin abundanceowingtodistressedmarketconditions.FHAwouldtherebyitselfbesolvingacollectiveactionproblem thenunderwriting(fragmented)marketundervaluationofthemortgagesinquestion.SeeHockett,Bailouts,Buy ins,andBallyhoo,52CHALLENGE36(2009),elaboratingmorefullyonproposalsmadebyauthorinseveralopeds overtheautumnof2008. Forreasonsadducedinfra,SectionsIIandIV,Ithinkthatatthispointthelocalrouteismorepromising thanthefederal,aswellas,forreasonsadducedinfra,SectionIII,lesscostlytothepublicfisc.(ThePlanproposed

 Statesandtheirinstrumentalitiestheirmunicipalitiesinparticulararebycontrast verywellsituatedtoplaytheappointedrole.12Thatinturnraisesthequestionbywhatmeans, andunderwhatlegalandconstitutionalauthority,statesandtheirmunicipalitiesmightbest dischargethiscriticalfunction. ThisMemorandumaddressesandanswersthatquestion.Theansweritreachesisthat traditionalstateeminentdomainauthority,astypicallydelegatedinturnbythestatestotheir municipalitiesandcognateauthorities,isbyfarthebestgrounduponwhichtoact.The Memorandumalsofindsthatacombinedcondemnationandmortgagerestructuringplanofa particularformwillbebyfarthebestlegallyandfinanciallyfeasibleoption.Weshallcallthis theMunicipalPlan(orthePlan). TheMemorandumproceedsasfollows.SectionIdescribesthesourceandstructural dynamicsoftheongoingmortgagecrisisstillfacingthenation,itsstates,andtheir municipalities.13SectionIIthenoutlinesthegeneralformthatsolutionstocrisesofthiskind musttakeaformthatcorrespondstothestructureofthecrisisitself.SectionIIalsoexplains whynosuchsolutionhasyetbeenforthcoming.14Inessence,itindicates,coordinationhurdles ofthesameformasrenderedthecrisispossiblenowrenderitssolutionimpossible,absent somedulyauthorizedcollectiveagentabletoactonbehalfoftheinterestedpartiesarole,as justnoted,thatmunicipalitiesarebestsituatedtoplay. SectionIIIthendetailsthePlanmentionedabove,indicatingbothhowitsstructure respondspointforpointtothestructureofthecrisis,andhowitsuseoftheeminentdomain authoritycapitalizesonmunicipalitiesoptimalpositioningforpurposesofcollectively addressingthecoordinationchallengesthatnowunderwriteongoingmortgageinertia.15Italso emphasizestheroleofpublic/privatepartneringbetweenmunicipalitiesandlendersincluding lenderswhocurrentlyholdmortgagedebtinthePlan.Itemphasizeshowthisfeature enablesmunicipalitiestoproceedatnocosttothepublicfiscanotherimportantadvantage, particularlyinstrappedtimessuchasthese.

hereisinvestorfunded.)Theauthorcontinuestothinkalonghisownearlier,aswellProfessorJacksons,lines, however,infindingthatfederalactionwouldstillmakeforawelcomecomplement.Seeagaininfra,SectionII. Asexplainedmorefullyinfra,SectionsIIIthroughV. 12 Commencingatpage4. 13 Commencingatpage15. 14 Commencingatpage28.AppendixA,whichcomplementsthisSection,providesfullerfinancialdetailfor 15 thosepossessedofmorespecializedtransactionalknowledgeintheformofasamplehypotheticaltermsheet.

SectionIVcomprehensivelylaysoutthelegalandconstitutionalbasisofthePlan, indicatinghowthelattercarriesoutpreciselythatpurposewhichunderliesthetraditionalstate eminentdomainauthority.16SectionVthencataloguestheimmenselydestructivespillover consequencesforborrowers,lenders,neighborhoods,families,localpropertyvaluesand assessments,localrevenuebases,stateandlocaleconomies,socialservices,crimerates,and moreoffurtherdelayinaddressingthecrisis.17Preventionofalloftheseconsequences,it indicates,constitutespreciselythatexigentpublicpurposeforwhichstateeminentdomain authorityexistsinourlaw. AlthoughthisMemorandumconstitutesanintegratedwhole,readerswhoare interestedprimarilyinthePlansfinancialandeconomicdetailsandrationalewillwishtofocus particularlyonSectionsIthroughIII.Readerswho,bycontrast,areinterestedprimarilyinthe PlansconstitutionalbasisandlegalproceduraldetailshouldfocusparticularlyonSectionsIII throughV. Becausetheapplicablelawreferencedhereis,byitsterms,particularlysolicitousofthe financial,broadereconomic,andattendantnecessitiesfacedbylocalitiesinextremis,however, andisindeedpartofourfederalsystempreciselyinordertoaffordtheselocalitiesmeansof efficientaddressofthesame,thefinancialandeconomicanalysisoftheearlierSectionscannot butinformthespecificallylegalandconstitutionalanalysisofthelaterSections.Itishoped, then,thatatleastsomereaderswillreadallthatfollowsratherthancherrypicking. Onthatintegrativenote,theMemorandumsConclusiontiesuplooseendsandlooks forward.18Againstthebackdropofuptotenormoremillionimpendingforeclosurestocome intheverynearfuture,19itsuggests,weareapttoseemanymunicipalcondemnationactions, broughtpursuanttosundryspecific,locallyresponsive,finelytunedvariantsofthePlanhere described,inthemonthsjustahead. I.ThePresentCrisisRootCausesandStructuralDynamics Asobservedaboveinintroducingthepresentdiscussion,thenation,thestates,our citiesandeventhegloberemaintrappedinthefalloutofafinancialcrisiswhoseepicenter
16 Commencingatpage35.AppendixB,whichcomplementsthisSection,providesfullerlegaland constitutionaldetailforthosepossessedofmorespecializedlegalproceduralanddoctrinalknowledgeintheform ofasamplehypotheticalfilingandsupportingbrief. Commencingatpage48. 17 Commencingatpage54. 18 Seeagaininfra,SectionII,forthisandadditionaltellingstatistics.AlsoSectionV. 19

comprisedandcomprisesanotverylargenumberofU.S.localities.20Thecrisisitselfwasthe culminationofadecadeslongcreditfueledassetpricebubblethatfocusedprimarilyon residentialrealestate.Thelatterforitspartbothwas,andremains,disproportionatelylocated inFlorida,California,andseveraladditionalsunbeltorsandstates.21 Thecreditinquestion,foritspart,stemmedinthemainfrompersistent,historically unprecedentedtradesurplusesthatwereaccumulatedovermorethanadecadebyheavily lowwagelaborendowednewentrantstotheliberalizedglobaleconomyfollowingthe breakupoftheoldeasternblocoferstwhilesocialistnations.22Flowsofthiscreditwere particularlydifficult,ifnotindeedimpossible,fordomesticmonetaryauthoritiesliketheU.S. FederalReservetosterilize,giventheopennessofU.S.financialmarketstothewiderworld.23 Thetheretoforeunprecedentedglobalsavingsglut,asthenFederalReserveGovernor BenBernankechristeneditin2005,24servedasthepredicatetoaclassicrecursivecollective actionproblemofthekindnotedaboveinintroducingthisMemorandum.Thehallmarkof theseproblems,again,istheircapacitytobringaboutsituationsinwhichmultiple uncoordinateddecisionsevenblameless,individuallyrationalsuchdecisionsaggregateinto collectivelyselfdamningoutcomes.25 Armsraces,bumsrushes,bankrunsandbustsarefamiliarexamplesofthiscommon phenomenonasare,innonrecursiveform,thosegametheoreticperennialsknownasthe prisonersdilemmaandtragedyofthecommons.26Sotoo,wenowknow,areassetprice bubblesandbusts.27

20 Asmorestatisticsrelatedinfra,SectionIIreveal,affectedcommunitiesaredisproportionately,though certainlynotsolely,locatedinFlorida,California,andneighboringsouthwesternstates.Inthissense,thesituation isnotunlikethatwhichfollowedthenationslastresidentialrealestatebubbleandbust,inthelate1920s.See Hockett,AFixerUpperforFinance,supranote5;alsoHockett,Bailouts,BuyIns,andBallyhoo,52CHALLENGE36 (2009). Seesupra,note20.Alsoinfra,SectionII,forrelevantstatistics. 21 NotablyChinaandtheEastAsiantigereconomies,butalsoothers.SeeDanielAlpert,RobertHockett, 22 andNourielRoubini,TheWayForward:MovingPastthePostBubble,PostBustEconomytoRenewedGrowthand Competitiveness,WhitePaper,NewAmericaFoundation,October2011. SeeAlpert,Hockett,&Roubini,TheWayForward,id.AlsoHockett,BrettonWoods1.0supranote6. 23 SeeBenS.Bernanke,TheGlobalSavingsGlutandtheU.S.CurrentAccountDeficit:Remarksatthe 24 SandridgeLecture,VirginiaAssociationofEconomists,March10,2005,availableat: http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/. 25 SeeAlpert,Hockett,&Roubini,TheWayForwardsupranote22;alsoHockett,AFixerUpperforFinance, supranote5;andRobertHockett,Bubbles,Busts,andBlame,37CORNELLL.FORUM14(2011). Seesourcescitedid.Thestandardrenditionsoftheprisonersdilemmaandtragedyofthecommonsdo 26 notinvolvefeedbackeffectsandaccordinglyneednotbeselfworsening.Indeed,collectiveactionproblem solvingconventionscansometimesemergepursuanttoiterationofthesesituations.Whatwearecallingrecursive collectiveactionproblems,bycontrast,simplyselfworsenwithiteration,henceinvolveeitherindeterminate

 Theprobleminthepresentinstance,withwhosesequelaeacomparativelysmall numberofU.S.municipalitiescontinuedisproportionatelytostruggle,unfoldedontheone handpursuanttotheclassicfamiliarpattern,whileontheotherhandonthestrengthofthe historicallyanomalousglobalcreditglutjustnoted.28Foraslongasthatsurplusofcredit remaineddisproportionatelyattractedtoU.S.dollardenominatedassetsas,giventheunique globalroleofthedollar,itwasboundtodoforaslongasourtradingpartnersdeclinedto recyclethemathome29borrowingcostsinthiscountrycouldnotbutremainlow.30Andso theydid,forwelloveradecade.31 Butwhencreditcostsintheformeitheroflowinterestchargesorhighobtainable loantovalueratios(LTVs)remaininexpensiveoversomelengthyinterval,andatsomepoint earlyoninthatintervalsomediscreteclassofassetslikerealestateandthefinancial instrumentsappurtenanttoitbeginrisinginvalue,forwhateverexogenouslygivenreason,at

equilibriaornoequilibriaatall.SeeagainHockett,RecursiveCollectiveActionProblems,supranote5;and Hockett,BrettonWoods1.0,supranote6.. Someofcoursedonotsimplynowknowthis,butlongineffecthaveobservedit.Seesourcescited 27 supra,notes25and26.SeealsotheworkofGeanakoploscitedinfra,note33;andtheimportantworkon procyclicalityinthemonetaryandfinancialsystemsofmycolleagueTobiasAdrianwithHyunShin,e.g.Tobias Adrian&HyunSongShin,ProcyclicalLeverageandValueatRisk;FRBNYStaffReports,No.338(2011),availableat http://www.newyorkfed.org/research/staff_reports/sr338.html;TobiasAdrianetal.,MonetaryCycles,Financial Cycles,andtheBusinessCycle,FRBNYStaffReports,No.421(2010),availableat http://www.newyorkfed.org/research/staff_reports/sr421.html;andTobiasAdrianetal.,FinancialIntermediation, AssetPrices,andMacroeconomicDynamics,FRBNYStaffReports,No.422(2010),availableat http://www.newyorkfed.org/research/staff_reports/sr422.html.SeealsoHYUNSONGSHIN,RISKANDLIQUIDITY(2010). 28 SeeAlpert,Hockett,&Roubini,TheWayForward,supranote22. Thereasonsforhoardingdollardenominatedassetshaveincluded,interalia,foreignexchangeholdingfor 29 defenseagainstpossiblespeculativeattacksupondomesticcurrenciesofthekindthatcharacterizedtheAsian FinancialCrisisofthelate1990s,domesticinflationpreventioninthehighgrowthratesathome,possiblecurrency manipulationinordertomaintainexports,andother,lesspressingimperatives.SeeAlpert,Hockett,&Roubini, TheWayForward,supranote22;andHockett,BrettonWoods1.0,supranote6.AlsoMARTINWOLF,FIXINGGLOBAL FINANCE(2nded.,2010). Seesourcescitedsupra,notes22,23,and24.Pleasenotethat,forthetimebeingatleast,withtheterm 30 borrowingcostsIamlumpingtogethercreditoftheformextendedinreturnforinterestpaymentsontheone hand,andcreditthatvarieswithavailableleverageratiosasdeterminedbyvaryingcollateralrequirementsonthe otherhand.Therearesomecontextsandassociatedpurposesforwhichitisimportanttodistinguishthem,for reasonsverywellconveyedbyGeanakoplosinthesourcescitedjustbelow,note33.Forthemoment,thepresent contextisnotoneofthem. TheFedinduringtheeratowhichweherealludemighthavebeenabletodomorebywayofreiningin credit,includingthroughinterestratepolicyor,morepotently,theregulationofleverageratios.Buttherewere reasonsforittobecautiousaboutdoingso,andthefreeinflowofcreditfromabroadunderliberalglobalfinancial arrangementswouldhaverenderedthetaskbothdelicateanddifficultinanyevent.See,e.g.,Alpert,Hockett,& Roubini,TheWayForward,supranote22;Hockett,AFixerUpperforFinance,supranote5;andHockett,Bretton Woods1.0,supranote6. Seeagainsourcescitedsupra,notes22,23,and24. 31

morerapidratesthantheeffectiveinterestorcollateralhaircutrates,itquicklybecomes rationalformoreindividualsthanbeforetobeginborrowingandbuyingtheassetsinquestion. Moreover,andmoreominouslyforpresentpurposes,italsobecomesrationalforat leastsomeindividualssocalledspeculativebuyerstoborrowtobuyonlytosell,witha viewultimatelytoprofitingontheemerging,thenwideningspreadbetweenlowborrowing costsandhigh,thenacceleratingcapitalappreciationrates.32Andthesecomparativelyfew speculativebuyers,crucially,comeincreasinglytodeterminethepricesthatevenconservative buyersmustpayandindeedborrowtopay.33 Onceevenarelativelysmallthresholdnumberofspeculativemarketactorsbeginacting onrationalspreadleggingcalculationslikethese,theensuingcreditfueledassetappreciation processcanbecomeselfaccelerating.Itcandoso,indeed,foraslongasthecreditthatfuelsit remainsoverabundant.Morebuyingthencomestomeanmorepricerises,whichmeans greaterspreadsbetweenlowleveringcostsandhighcapitalgains,whichinturnbringsonmore expectationofyetfurtherpricerises,whichissuesinfurtheracceleratedbuying34andsoon,

32 Seesourcescitedsupra,note25.Theassetsinquestionmightfirstbegin(moderately)risinginvaluefor reasonsrootedinfundamentalsforexample,demographicchangesthatbringmorefirsttimebuyersinto housingmarkets.Theproblemisthatoverabundantcreditcanthenenableeveninitiallymoderatepricerises rootedinfundamentalstoaccelerateintomuchsteeperpricerisesrootedincreditenabled,selffulfillingpricerise expectationsthemselves. Thispointiscritical,particularlywhenquestionsofblameareontheagenda.Oneneedednotbea 33 houseflippertogetcaughtupinandthusinadvertentlyfurthercontributetothemortgagebubbledynamic,any morethanoneneedbeabreadflippertobedrawnintoandtherebycontributefurthertothedynamicofa consumerpricehyperinflation.Perfectlysober,evenregretfulpartiescanbepromptedtobuynowratherthan latersimplybyrationalrecognitionofthefactthat,solongastheinflationorhyperinflationisunderway,prices willbesomuchhigherinfutureastorenderitsensibletobuynowratherthanlater.Italsobearsnotingthatnot onlyspeculators,butfraudstersaswellcandisproportionatelydeterminethesehighermarketpricesthatthegreat majorityofsoberandhonestpurchasersmustpay.SeeHockett,AFixerUpperforFinance,supranote5;Hockett, Bubbles,Busts,andBlame,supranote25;andHockett,RecursiveCollectiveActionProblems,supranote6. Creditforfirstrigorouslymodelingthedisproportionateinfluenceofoptimistsinageneralequilibrium modelwithheterogeneousinvestorsrestswiththeprescientandeverbrilliantJohnGeanakoplos.SeeJohn Geanakoplos,Promises,Promises30507,inTHEECONOMYASACOMPLEXEVOLVINGSYSTEMII,pp.285320(W.B.Arthur etal.,eds.,1997);JohnGeanakoplos,Liquidity,Default,andCrashes:EndogenousContractsinGeneralEquilibrium, inADVANCESINECONOMICSANDECONOMETRICS:THEORYANDAPPLICATIONS,ECONOMETRICSOCIETYMONOGRAPHS,EIGHTHWORLD CONFERENCE,2:170(CambridgeU.Press,2005);and,morerecently,JohnGeanakoplos,TheLeverageCycle,NBER MACROECONOMICSANNUAL,pp.165(2010),at43.Thesameworkshighlighttheimportanceofdistinguishing betweeninterestandleverage(collateral)insomecriticalcontexts.Theydonotreferencefraudsters,butthelogic carriesovertotheircaseaswell. Noteagainthattheacceleratedbuyingmightbedonebyspeculatorsorfraudstersactingpursuantto 34 profitmotives,butalsomightbedonebyordinarybuyandholdbuyerswhosimplydecidetobuysoonerrather thanlaterinordertoavoidhavingtopaymoreatlaterdates.Inthissensethebubbleis,again,muchlikea consumerpricehyperinflation,whichcanbefuelednotonlybycommoditiesspeculatorsbutalsobyordinary consumershopingtopreempthigherpaymentrequirementsapttosetinatlaterdates.

foraslongas(1)theleveringremainsinexpensive,and(2)thereremainfurther,untapped prospectivenewentrantstoaffectedmarkets.35 Andagain,itbearsemphasis,thecomparativeminorityofspeculativebuyersinthese circumstancesincreasinglydeterminethepricesthatallentrantsmustpay.Evencautiousnew buyandholdpurchaserswhowouldhaveenteredthehomemarketsinanyeventayoung coupleornewfamilyseekingtheirfirsthome,sayeffectivelyfallhostagetothedecisionsof levereduphouseflipperswhosepurchasesthecreditglutrendersprospectivelyprofitable.36 Therealestatebubbleofthelater1990sandearly2000swasselfacceleratingpursuant topreciselythisfeedbacklooppattern.Asmoreinvestorsnoticedtheprofitstobemadeby purchasingresidences,mortgagebackedsecurities(MBS),orassociatedinstrumentsonlow costcreditandthenreselling,moreweredrawnintoorotherwiseaffectedbysuch transactions. Somewereofcoursepromptedbyspeculativeprofitseekingfortheirownaccounts. Otherswerepressedintoparticipatingbyclientsonwhoseaccountstheytraded.37Stillothers werepressedineffectbythespeculatorsthemselves,viathedisproportionateimpactthe latterstransactionsexertedonpricesthatevenordinaryfolkhadtopayand,increasingly,to borrowtopay.38Andasmorecametotransactontheseterms,pricesnaturallyrosehigher,at acceleratingrates,increasingprofitopportunitiesyetfurther. Ineffect,aspontaneouslyemergentPonzi,orpyramidprocessdevelopedinthe nationslargestprimaryandsecondaryrealestatemarketsoverthe1990sandearly2000sa processthat,crucially,requiresnoactualPonziorschemertocommenceorpersist.39Thenon
35 Thisisofcoursewhataccountsforsomemortgageoriginatorshavingsoughtevermoremarginal borrowerstowhomtolendonevermorerisky,subprimetermsandevennonmarginalbuyerstoswitchinto moremarginal,higherriskhigherreturnmortgagearrangementsasthepoolofprospectivenewbuyersshrank andthebubbleneareditsprospectivenewentrantdeterminednaturallimitingperimeter.Italsoaccountsforthe uptickinfraudulentcreditpracticesasthelimitsofpoolsofnewentrants,andthusofthebubbleitself,wereat longlastapproached.SeeHockett,AFixerUpperforFinance,supranote5. Itbearsnoting,moreover,thatmanyofthesespeculativebuyersandfraudsterswhosepurchasessetthe 36 pricesthatevencautiousandhonestbuyershadtopaypurchasedmultipleproperties,ineffectleveringuptheir owninfluenceonprices.Seeid. Muchanecdotalevidencesuggeststhatmanyhedgefundmanagerssoughttopulloutoforevenshort 37 realestateduringthelatestagesofthebubble,onlytobetoldbytheirclientsthattheywouldwithdrawtheir fundingandinvestelsewherewerethemanagerstodoso.See,e.g.,Hockett,FixerUpper,supranote5;and Geanakoplos,Promises,Promises,supranote33. Seesourcescitedsupra,note33. 38 ThisisacoremessageofHockett,FixerUpper,supranote5,inwhichthetermspontaneouslyemergent 39 Ponziprocessisintroduced.SeealsoHockett,Bubbles,Busts,andBlame,supranote25;andHockett,Recursive CollectiveActionProblems,supranote6.Blametheremighthavebeen,butitisaltogetherunnecessarytoexplain

necessityofanysuchPonziorschemerintheseprocessesisimportant.Itispreciselythesense inwhichprocessesofthissortstemfromclassiccoordinationproblemsproblemsthatresult from,ratherthandefying,individualrationality,evenethicallyblamelesssuchrationality. Thisisnottosaytherewasnoblameorirrationalityduringourrecentpropertyprice bubble;therealwaysis,bubbleorno.40Itisonlytosaythatthesewouldhavebeeninessential, andinthatsensedidntlieatthecoreofthecrisis.41Allthatwasneededwasunderpriced credit,whichwasdestinedtoremainunderpricedforaslongastheaforementionedcapital surplusesbuiltupinAsiaandelsewhereovertheyearsleadingintothecrisisheldoutor,worse yet,continuedtogrowastheydid. Hencethereisnoneedtopointfingersatanyonehomebuyer,lender,orsecondary marketinvestorinexplainingwhathappened.Thereisonlyaneedtoclearupthewreckage thattheseindividualsarenobetterpositionedcollectivelytoclearthantheyweretoprevent. Toappreciateallofthismoreconcretely,itisinstructivebeforemovingontoconsidera typicaltransactionoftheerafromthedistinctpointsofviewofthepartiesconcerned. Fromthelendersorinvestorspointofview,thenwhetherfirstmortgageeorsecond, portfolioloanholderorMBSbuyeritmadesenseduringtheboomtomakeinvestmentsthat wouldhavelookedlessprudentinearliertimes,preciselyinvirtueofthesteadyappreciationof collateralwroughtbythebubbleitself.42Borrowerswere,afterall,lessapttodefaultgiventhe luxuriantrefinancingopportunitieswhichthatappreciationafforded.Andthegrowing expectedvalues(EVs)ofperformingloansandunderlyingcollateralmorethanoffsetexpected lossesfromincrementaldefaultrateincreasesinanyevent.43 Fromthebuyerspointofview,inturn,acceptingloansfromthementionedinvestors evensecondsuchloans,andthehighercostnonprime,orhighercomplexityadjustablerate loansthatmanyoriginatorsincreasinglychanneledthemtoward44madesensebothfor

whathappenedoverthecourseofourmostrecentbubbleandbust.TheideaofanaturallyoccurringPonzi processfiguresprominentlyintheexceedinglyprescientROBERTSHILLER,IRRATIONALEXUBERANCE(2000),which introducesthiscriticallyimportantidea. Seeagain,inparticular,Hockett,Bubbles,Busts,andBlame,supranote25. 40 41 Id. SeeagainHockett,AFixerUpperforFinance,supranote5;andHockett,RecursiveCollectiveAction 42 Problems,supranote6. Id. 43 Formoreonthelenderschannelingevenprimeborrowerstowardmoreprofitablenonprimeloans,see, 44 e.g.,Hockett,AFixerUpperforFinance,supranote5;alsoCHARLESMORRIS,THETWOTRILLIONDOLLARMELTDOWN(2d ed.,2010).

distinctreasonsandforthesamereasonsthatextendingthiscreditmadesensetoinvestors: Foronething,asnotedabove,mostbuyershadlittlechoicebuttobuyonthetermssetbythe speculatordrivenboommarketitself.Foranother,appreciatinghomevaluesmaderefinance easyinanyevent,wellbeforeadjustableratemortgageloanpaymentsmightadjustupward. Indeed,thethenesteemedFedChairmanpubliclytoldbuyersasmuch.45 Thatofcoursetakesustotheregulators.Frommanyoftheirpointsofview particularlythosewhowerenotchargedwithoverseeingthefinancialormonetarysystemsas integratedwholesheightenedregulatoryconcernlookedunnecessaryforcounterpart reasonstothosejustconsidered.46Steadilyrisinghomevaluesmeantlessrisklessriskto borrower,lender,secondarymarketinvestor,andhencegeneralpublicalikefromthepointsof viewofthesenonsystemicregulators.47 Muchthesamecalculusappearstohaveaffected,inthiscasemoreproblematically,the thinkingofthatauthoritychargedwithoverseeingourfinancialsystemasonesystemically integratedwholeonbehalfofallactorsthatallimportantcollectivemonetaryagentknown astheFed48thoughinthiscasetherewereadditional,seeminglymorecompellingreasonsto standback.49 Onesuchreasonstemmedfromthesalutaryconsequencesofthewealtheffect wroughtbyhomepriceappreciationonconsumerdemand.Thesewereconsequencesthat wereboundtoappealinviewof(1)U.S.growthandemploymentimperilingrealwage stagnationfromthe1970sonward,combinedwith(2)theFedsmaximumsustainablegrowth andemploymentmandates.50 AnotherseeminglycompellingreasonforFedinactionwasthefactthatitlikelycould notfullysterilizeincomingcreditinanyeventatleastnotwithouteither(1)backtrackingon

See,e.g.,GreenspanSaysPersonalDebtisMitigatedbyHousingValue,N.Y.TIMES,Feb.24,2004,atC11. SeeHockett,AFixerUpperforFinance,supranote5;Hockett,Bubbles,Busts,andBlame,supranote25. 46 Id. 47 48 Thecriticalroleofthecentralbankormonetaryauthorityasnecessarycollectiveagentinrespectofthe financialsystemisacentralthemeofHockett,AFixerUpperforFinance,supranote5;Hockett,Bubbles,Bustsand Blame,supranote25;andHockett,BrettonWoods1.0,supranote6.SeealsoRobertHockett,Money,Finance, andCollectiveAction,6J.APP.ECON.__(2012). SeeagainHockett,BrettonWoods1.0,supranote6. 49 SeeAlpert,Hockett,&Roubini,TheWayForward,supranote22.Thementionedmandateiscodifiedat 50 12U.S.C.225(a).
45

10

globalfinancialopenness,or(2)usingbluntpolicyinstrumentswidelythoughtapttokill healthytransactionactivityeconomywide.51 Inshort,then,evenaltogetherblamelessdecisionstakenbyallconcernedparties,with thepossibleexceptionofthatcollectiveagentthatisthecentralbank,wouldhavebeen consistentwithwhatwehavebeenthroughand,asSectionIIwillsoondemonstrate,whatwe arestillgoingthrough.Itwaspreciselymostpartiesactinginfinanciallydefensiblemanners thatenabledthebubbletoform,thenexpandforaslongasthecreditremainedinexpensive andprospectivenewentrantstorealestatemarketscouldbetapped. Andforaslongasthisprocesscontinued,inturn,eventhegreatmajorityofsober,non speculativeinvestorsandhomebuyershadtotransactontermssetbythebubble.Home buyerswereforced,inotherwords,toenterintofixeddebtobligations,witheverhigher principal,simplyinordertopurchaseandinhabitevermoreexpensive,speculativemarket valued,variablypricedhomes.52 Oncethepoolofprospectivenewhomebuyerswasfinallyexhausted,however,and pricesinconsequencepeakedandthenplunged,millionsofhomebuyerscouldnotbutnow findthemselvessuddenlyunderwater,hunkeringdownunderdebtoverhangwith negativeequity.Theirvariablerateassetsnottomentionlendercollateralhad plummetedinvalue,whiletheirfixeddebtobligationshadnot.Thatleftthemwithmorein debtobligationsoftenverymuchmorethaninunderlyinghomeequity.

51 SeeHockett,BrettonWoods1.0,supranote6.Itisperhapsworthnoting,ifonlyinpassing,thatscholars attheBankforInternationalSettlementsnotablyClaudioBorioandWilliamWhitehavebeenconsistently moreoptimisticabouttheprospectsofleaning(againsttheproverbialwind)asdistinguishedfromcleaning(up afteracrash,thepolicypreferredinAmericancirclessincetheendoftheMartinandVolckereras,atanyrate). SeeagainHockett,AFixerUpperforFinance,supranote5;Hockett,Bubbles,Busts,andBlame,supranote25;and Hockett,Money,Finance,andCollectiveAction,supranote48.Averygoodoverviewoftheproleaningposition, withcritiqueoftheprocleanposition,isWilliamR.White,ShouldMonetaryPolicyLeanorClean?,workingpaper, availableathttp://www.bnm.gov.my/files/publication/conf/hilec2009/s04_sp_white.pdf.TheAmerican consensusappearstobeshiftingnowabitmoretowardtheBISpositiononcefavoredbyearlierFedChairmen WilliamMcChesneyMartinandPaulVolcker,butitisnotthereyetandcouldnothavebeenfurtherfromitover thecourseofthelate1990sandearly2000s.Seesourcesjustcited.TheauthorandhisFRBNYcolleaguesTobias AdrianandMegMcConnellarenowworkingalongtheselinesinconstructingwhatwearecallinga macroprudentialtoolkit. See,again,HockettandGeanakoplossourcescitedsupra,note33.Itshouldbenotedthatbyfixed 52 nominaldebtobligationswemeanobligationsthatdonotchangewithmarketprices,incontrasttovariable marketpricesthemselves.Thelattersvaryingupwardiswhatopensspreadsandmakesborrowingtobuymore attractive;itsvaryingdownwardiswhatleavesdebtoverhangthatcaninducedebtdeflation.

11

Andasthisleftthemortgagorsvulnerable,ofcourse,sohasitleftmortgageeswhorely ontheirpaymentsalongwitheveryoneelsewhosewellbeingdependsonthehealthofthe mortgagemarkets.That,aswellsoonsee,isallofus. Sothisiswheremuchofthenation,andinparticularthosestatesandmunicipalities thathavebeensincethestartattheheartofthecrisis,nowfindthemselves.AsofJanuary 2012,fully$7trillioninhouseholdhomeequitywealthhadbeenlostsince2006,whilenearly onequarterover22%ofthe52.5millionmortgagedhomesintheU.S.wereunderwater.53 Ifforthesakeofillustrativecasestudyweconcentrateattentionon,say,California(the State)andoneofitscountiesinparticular,SanBernardino(theCounty)bothofwhichlay attheepicenterofthebubbleandbustthefiguresareyethigher:2millionhomes, representing30%ofthetotalStatewide,and168,000homes,representing43%ofthetotal Countywide.54Theseremarkablenumbersareofcoursebutthebalancesheetmanifestations ofslumpedandstillsagging,recordlowpostbubblehomepriceswhich,nearlysixyearsafter thepeakandtheplunge,aredown34%from2006levelsnationwide,50%Statewide,andover 50%Countywide.55 Yetallofthis,worrisomeasitallis,isnotall.Mattersaregrowingyetworse. Notwithstandingperiodicallytransient,scatteredsignsofimprovementinsomeshifting nationallocalities,theS&PCaseShiller20CityIndexnowshowshomepricesdownfully9% fromtheirpreviouspostbubblehighitselflowinrelationtolongertermtrendreachedin 2010.56ThecounterpartstateandCountyfiguresareproportionatelyworse:approximately 11%fortheState,and14%fortheCounty.57Meanwhile,abacklogofnearly400,000homes nationwideawaitedliquidationattheendof2011,withanother2.86millionmortgagestwelve ormoremonthsdelinquent.58AndagaintheStateandCountyfiguresareworse.59
53 CoreLogic.SeealsoAlpert,Hockett,&Roubini,TheWayForward,supranote22.AlsoMichaelCampbell &RobertHockett,WhitePaperinSupportoftheHomeMortgageBridgeLoanAssistanceActof2012,availableat http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1987159. 54 CoreLogic.FormoreonwhySanBernardinomakesforanillustrativecasestudy,see,e.g.,Jennifer Medina,InCalifornia,EconomicGapofEastvs.West,NEWYORKTIMES,April14,2012,page1,availableat http://mobile.nytimes.com/article;jsessionid=ADA9B1FACB49BF39B4CF50B58646AFBF.w6?a=938651&f=19. 55 Seewww.dqnews.comforState$484Kin2007and$239KinFeb2012andwww.CityData.comfor Countyapproximately$380Kin2007and$155Kin2011. SeeRobertHockett,SixYearsOnandStillCounting,supranote3;andCampbell&Hockett,WhitePaperin 56 SupportoftheHomeMortgageBridgeLoanAssistanceActof2012,supranote53. Seewww.dqnews.comforState$270KinJuly2010and$239KinFeb2012andwww.CityData.com 57 approximately$180Kin2010and$155Kin2011. Id. 58 Figuresforthcoming. 59

12

Theupshotofthesenumbersisacurrentshadowinventoryofsome3.25million homesnationwide,174,000homesStatewide,and14,000homesCountywidethatareeither alreadyforeclosedoronthebrinkofforeclosure.60Theseareinventorieswhich,asthey continuetogrow,weighallthemoreheavilyonhomeprices,families,neighborhoods,towns, andthenational,state,andlocaleconomies.Inlightofthesetrends,widelyfollowedreal estateanalystsestimatethatbetween7.4millionand9.4millionadditionalhomeloans nationwidenowareatseriousriskofdefaultinthecomingsixyears.Thatisanimpending foreclosuretsunamiofapparentlyunprecedentedproportion,ratherasourrecentbubbleand theglobalglutfuelingitwereeitherunprecedentedoronlyonceprecedented.61Andthisis assumingnofurtherpricedeclinesorinterestraterises. Butalas,owingtofeedbackeffectsofthesortsketchedaboveandtobeencountered againjustbelow,furthersuchpricedeclinescannotberealisticallyassumedaway.62 Underwaterhomeownerswholiveintheshadowofdebtoverhangdontspend.Thatdrains growthandemploymentmaintainingconsumerdemandfromtheeconomy.Becausehomes representbyfarthelargeststoreofwealthforthegreatmajorityofmiddleclassAmericans, moreover,63andbecausethatmiddleclassinturnrepresentsbyfarthegreatestsourceof

60 CoreLogic,September2011. SeeTestimonyofLaurieS.Goodman,AmherstSecuritiesGroup,totheU.S.SenateSubcommitteeon 61 Housing,Transportation,andCommunityDevelopment,March15,2012,availableat http://banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=0f96e0ff850041a5a0f2 0139d0df2e07;andLaurieGoodmanetal.,TheCaseforPrincipalReductions,17J.STRUC.FIN.29(2011).AlsoGus Lubin,LaurieGoodmanonWhyAnother11MillionMortgagesWillGoBad,BusinessInsider,July26,2011, availableathttp://articles.businessinsider.com/20110726/markets/30092548_1_shadowinventorydefault ratesloans. Theonepossibleprecedent,ofcourse,isthatoftheglobalandU.S.financialandhousingeconomiesof thelate1920sand1930.SeeHockett,AFixerUpperforFinance,supranot5forreminderthatthe1920sfeatured arealestatebubbleinadditiontoafinancialmarketbubble,thepairingofwhichtwoalwaysseemstoissueinthe longestrunningpostbustdebtdeflations.AlsoHockett,AJeffersonianRepublicThroughHamiltonianMeans,79 S.CAL.L.REV.53(2005).Asfortheuncertaintywhetherthepriorcaserivaledorsurpassedthemostrecentin magnitude,thisowestowantofdatainconnectionwiththepreviousinstance.SeeAlpert,Hockett,&Roubini, TheWayForward,supranote22.Ondebtdeflations,seethesame;thelocusclassicus,foritspart,isofcourse IrvingFisher,TheDebtDeflationTheoryofGreatDepressions,1(4)ECONOMETRICA337(1933). See,e.g.,Alpert,Hockett,&Roubini,TheWayForward,supranote22;FederalReserveBoard,supranote 62 8;Dudley,supranote8;andCampbell&Hockett,WhitePaperinSupportoftheHomeMortgageBridgeLoan AssistanceActof2012,supranote53,forfurtherelaborationofthedynamicsdescribedinthisparagraph.See alsoAdrianandShinsourcescitedsupra,note27,andGeanakoplossourcescitedsupra,note33.Finally,seeagain Fisher,ascitedid. ThisisanotherimportantmotifintheworkofRobertShiller.SeeSHILLER,IRRATIONALEXUBERANCE,supra 63 note39.AlsoROBERTSHILLER,MACROMARKETS(1993);ROBERTSHILLER,THENEWFINANCIALORDER(2003);andROBERT SHILLER,THESUBPRIMESOLUTION(2008).SeealsothesecondeditionoftheaforementionedIRRATIONALEXUBERANCE, publishedin2005withadditionchaptersonthehousingbubble.AndRobertHockett,JustInsuranceThrough GlobalMacrohedging,25U.PA.J.INTLECON.L.107(2004).

13

Americanconsumerdemand,thedragonthelargereconomyismassive.Indeeditisbyfarthe heaviestdragongeneralpostcrisisrecovery.64 Tobesure,notallcurrentlytroubledmortgagesareunderwater.Somehomeowners arenowfacingdifficultykeepingcurrentonmonthlypaymentssimplyforreasonsoftemporary unorunderemploymentstemmingasradialeffectsfromthebroaderunderwatermortgage inducedslump.Forthisclassofmortgagor,theauthorofthisMemorandumandacolleagueat theFedhavedesignedaHomeMortgageBridgeLoanAssistanceProgram,informedbya successfulPennsylvaniaprogramputintoplaceduringthesteelslumpoftheearly1980s.The billthatwouldinstitutetheprogram,happily,isnowpoisedforadoptionintheStateofNew York.65But Critically,however,thisclassoftroubledmortgageisnowherenearbeingtheprincipal draguponmortgagemarketandmoregeneraleconomicrecovery.Thatstatusis overwhelminglyheldbyunderwatermortgages,whichdefaultatacceleratingratesin proportiontotheirnegativeequity,sufferdisproportionatelossesonliquidation,andradiate throughthelargereconomypursuanttothefeedbackmechanismsnotedintheprevious paragraphbutone.Andnotwithstandingthisfactthatfactthattheyaretherealproverbial elephantintheroomtheyarelikewise,ironically,theoneclassoftroubledmortgageabout whichvirtuallynothinghasbeendone.Thisinturnstemsfromwhatturnouttobeyetmore coordinationchallengesthatweelaboratenext,inSectionII. Ourforeclosurecrisis,then,badenoughalready,ispronetocontinuedselfworsening justasthebubblefromwhichitproceedswasselfaugmenting.Massforeclosuresand expectedforeclosuresfurtherdepresshomeprices,whichfurtherdepressconsumer expenditures,whichfurtherdepressemploymentandincome,whichfurtherheightenthe incidenceofdefaultandforeclosure,whichfurtherdepresshomepricesandsoon, snowballingagain.66Andallofthis,ofcourse,correspondinglylessenstherealvalueofthose balancesheetovervaluedassetsmortgageloans,MBS,andassociatedinstrumentsstillon
64 Numbers.Seesourcescitedsupra,notes63and64.Forinterestinganecdotalevidenceaswellas citationstomultipleempiricalstudiesbyUniversityofChicagoeconomistAmirSufi,seeBinyaminAppelbaum, WhereHousingOnceBoomed,RecoveryLags,NEWYORKTIMES,April2,2012,p.1. SeeMichaelCampbell&RobertHockett,TheHomeMortgageBridgeLoanAssistanceActof2012, 65 availableathttp://www2.nycbar.org/pdf/report/uploads/9_20072233BridgeLoanAssistanceProgram.pdf.Also Campbell&Hockett,WhitePaperinSupportoftheHomeMortgageBridgeLoanAssistanceActof2012,supranote 53. Afewnumbersprovetelling:TheNationalAssociationofRealtors,initsDecember2011survey,finds 66 thatforeclosuresalesonaverageresultinadiscountof22%relativetonondistressedhomesales.(That comparesto20%asofDecember2010.)Shortsales,fortheirpart,averaged13%belowmarket.Id.Andthese areconservativeestimates,inasmuchasRealtyTrachasfoundevenlargerdiscounts.

14

thebooksoftheprimaryandsecondaryinvestorswhoseclaimsthesepropertiessecure.67No one,inotherwords,isspared. Theinterestedparties,meanwhile,hangbackinholdingpatternsorkickthe proverbialcandowntheroad,manyapparentlyhopingforsomemiracletohappenbefore therealityofmoremassforeclosure,eviction,propertydegradationandbookedasset devaluation,alltemporarilystayeduntilrecentlybyrobosigningscandalinducedcaution, recommences.68Thiswaiting,itselfrootedincoordinationhurdlesofthesamesortasenabled thebubbleandbustinthefirstplace,iswhatnowpermitsthedownwardspiralingtocontinue. OnlyaPlanoftheformdrawnupbelow,pursuanttowhichmunicipalitiesactascollective agentsforthefragmentedparties,canreversetheselfworseningtrend.ThefollowingSection explainswhy. II.WhatHastoHappen,andWhyItDoesNot Homepricesarenotgoingtorisebacktoprecrisis,boomperiodlevels.Iftheywere,it wouldnothavebeenabubblethatwevejustexperienced.Theexcesscreditfueled,artificially overvaluedhousingmarketjustwasthatbubble,henceispreciselywhatbroughtusthecrisis werelivingthrough.Againstthatbackdrop,theonlyconceivableoptionsforendingthe ongoingcrisisareeither(1)torestartandresumethebubbleitselfviasomeheretofore undiscoveredartifice,69or(2)torevalueassetsandliabilitiesformallyasthemarkets
67 See,e.g.,FederalReserve,supranote8;Dudley,supranote8;Campbell&Hockett,WhitePaperin SupportoftheHomeMortgageBridgeLoanAssistanceActof2012,supranote53. ForreasonsaddressedinfullfurtherbelowinthisSection,programslikethefederalgovernmentsHome 68 AffordableMortgageProgram(HAMP)andHomeAffordableRefinanceProgram(HARP)havebeennotably unsuccessful.Foronething,only2.26millionoutof14milliontroubledmortgagorshavemodifiedtheir mortgagesunderthesecostlyprograms.Foranother,moretroublingthing,fewerthan50%ofthese2.26million themselveswerestillcurrentatyearend2011.Thereasonisclear:Neitherprogramhassuccessfullyaddressed theunderwatermortgageproblemheadonbybringingsignificantprincipalreductionstoaffectedmortgages. Mostmodificationshavesimplycapitalizedpreviouslymissedmortgagepaymentsorreducedmonthlypayments bylessthan10%.Butitisoverwhelminglyunderwatermortgagesthatdefault.See,e.g.,Goodman,sourcescited supra,note61;alsoAlpert,Hockett,&Roubini,TheWayForward,supranote22;andChrisFooteetal,Negative EquityandForeclosure,FederalReserveBankofBostonFederalGovernmentPolicyDiscussionPapers083(2008), availableathttp://www.bos.frb.org/economic/ppdp/2008/ppdp0803.pdf. Noplanofactionthatdoesnotmakesignificantuseofprincipalmodificationsoastobringearlier, bubblepriceddebtintolinewithcurrent,postbubblecollateralvaluewilldoanythingmorethanputoffthe inevitabledayofrereckoning,andinsodoingworsenthelossesandharmsmentionedaboveandcatalogued morefullybelow.SeeAlpert,Hockett,&Roubini,TheWayForward,supranote1.AlsoFederalReserve,supra note8;Dudley,supranote8;Campbell&Hockett,WhitePaperinSupportoftheHomeMortgageBridgeLoan AssistanceActof2012,supranote53. SomehaveproposedtheartificeofmorecentralbankpurchasesofMBS,othersforexample,Ken 69 Rogoffand,morerecently,PaulKrugmantheartificeoftargetedhigherconsumerpriceinflation.See,e.g.,

15

themselveshavebegundoingrealistically.70Reflatethebubble,inotherwords,bringing variablerateassetsbackintolinewiththefixeddebtobligationsthatfinancedtheirpurchase, ortrimbackthedebtobligationsthemselves:writedownprincipal. Sinceoption(1),foritspart,isatbestonlyconceivable,notreallypracticableor desirable,71option(2)istheonlyrealisticanddesirablepossibility.Debtmustbetrimmedback toeliminatenegativeequity,elsethetimehonoredcorrelationbetweenhighLTVanddefault findexpressioninmoreroundsofforeclosure.Itisntaquestionofwhether,butwhenand how.Wecanacttoensurethattheoverhungdebtswrittenoffinanorderly,expeditious,well managedmannerthatisequitable,efficient,andvaluepreservingforall.Orwecancontinue tositbackandwatchthingsunfoldinamannerthatproveschaotic,uncertaintyfraught, inequitableandcolossallywasteful.72 Allpartiesrecognizethis.Sodocommentatorsacrossabroadspectrumrunningfrom ReaganAdministrationeconomistMartinFeldsteintograssrootsprogressivistoutfitslike MoveOn.org,andfromtopmortgageinsurerRadianGrouptotopbondfundPIMCO.What thenpreventsinterestedpartieswritingdownprincipalaccordingly?Whatblockstheiracting intheirownbestinterests?

KennethRogoff,TheBulletsYettoBeFiredtoStoptheCrisis,FINANCIALTIMES,August8,2011,availableat http://www.ft.com/intl/cms/s/0/1e0f0efec1a911e0acb300144feabdc0.html#axzz1s3nCG5bY;PaulKrugman, NotEnoughInflation,NEWYORKTIMES,April5,2012,availableat http://www.nytimes.com/2012/04/06/opinion/krugmannotenoughinflation.html?_r=1. Thesewouldamounttomerepartialreflationofthebubble,butareneverthelesssuboptimalforreasons elaboratedinAlpert,Hockett,&Roubini,TheWayForwardsupranote22.Onereasonisthattheproverbial inflationgenieisdifficulttogetbackintothebottleonceout.Theotheristhatinflationtends disproportionatelytoharmoldagepensionersandthosewithlowerincomes,atleastunlessanduntilweare preparedtocountenancecentralbanktargetingofmoreassetclassesinopenmarketoperations,perRobert Hockett,HowToMakeQEMoreHelpful:ByFedShortingofCommodities,BENZINGAFINANCE,October14,2011, availableathttp://www.benzinga.com/news/11/10/1988109/howtomakeqemorehelpfulbyfedshortingof commodities#. 70 SeeAlpert,Hockett,&Roubini,TheWayForward,supranote22;GoodmanTestimony,supranote61. AlsoCampbell&Hockett,WhitePaperinSupportoftheHomeMortgageBridgeLoanAssistanceActof2012,supra note53. Seesupra,note69. 71 Itshouldbenotedthat,inviewofthelossesentailedbydefaultandforeclosurethemselves,markets 72 valueforeclosurepronepropertiesandassociatedMBSatratesevenlowerthanmarkeddownandaccordingly nolongerforeclosurepronepropertiesandassociatedMBS.HencetheMunicipalPlan,thedetailsofwhichare laidoutinSectionIIIofthisMemorandum,shouldrestorehome,mortgage,andMBSvaluestoprecrisislevels, justnotbubbleeralevels.Formoreonthewayinwhichthesamerecursivecollectiveactionproblemasresultsin artificiallyovervaluedassetsduringabubbleresultsinartificiallyundervaluedassetsduringabust,seeRobert Hockett,Bailouts,BuyIns,andBallyhoo,52CHALLENGE36(2009);alsoHockett,AFixerUpperforFinance,supra note5;andHockett,RecursiveCollectiveActionProblems,supranote6.

16

 Inlightofwhathasbeennotedaboveaboutcoordinationproblems,itwillbe recognizedatoncethatthisisnotunlikeaskingwhatpreventsallpartiesfromexitingsafely fromaburningtheatre.Actionsthatwouldbetakenbymultiplepartiesinsituationslikethatin whichwenowfindourselves,iftheywouldnotbeselfdefeating,mustbeorchestrated.They inherentlyposecollectiveactionchallengesthatproperlyauthorizedcollectiveagentsin effect,orchestralconductorsmustaddressonbehalfofthemanydiffusepartiesconcerned. Inthissense,thepresentrevaluationimpassethechallengetoplenaryprincipal writedownsjustistheflipsideoftheprecedentbubbleitself.73Muchasitwasindividually rationalandindeedunavoidable,absentforcefulFedregulationofleverageconditions,for individualmarketactorstoenterintotransactionsthatultimatelyaggregatedintothebubble, andjustasitisindividuallyrational,absentdirection,foreachtheatergoertopresstowardthe exitonlearningoffire,soisitrationalforeachcreditorpostbubble,absentcombined orchestration,toawaitothersrevaluingfirst. Why?Thereareseveralreasonstocatalogue,butthemostdeepstructuraloneis thatthelasttorevalueinsuchcircumstancesultimatelyfacesleastneedtorevalue.Everyone elsesrevaluingeliminatesdebtoverhang,therebylowersaggregatedefaultrisk,andsoraises propertyprices.Thatinturnlessensthedegreetowhichanylastmortgageremains underwaterindeeditwillprobablyliftitabovewater.Everymortgageethereforehasreason towishtobelast,ratheraseachfleeingtheatregoerhasreasontowishtobefirst.74All accordinglywaitfortheotherstoact,ineffectreenactingtheVaudevilleroutineinwhichtwo partiesfirsttrytocrowdthroughonedoor,thenstepback,eachsaying,afteryou.Under suchcircumstances,noonegetsanywhere.75 Thisisofcourseproblemenough,structuralasitis.Andyetitisbutoneofthefull clusterofcollectiveactionproblemswefacewherewouldbeplenaryprincipalwritedownis concerned.Fortherearemanyadditionalimpediments,mostrootedincontractualpractices begunduringtheboomyearswhichfewthoughtwouldend,toprivatelyorderedloan modificationincontemporarymortgagemarkets.Itwillbehelpfulherebrisklytocataloguethe

73 SeeagainHockett,Bailouts,BuyIns,andBallyhoo,id.;andHockett,RecursiveCollectiveActionProblems, supranote6. Thesymmetryhereisnoaccident.Notethatbubbleparticipantsalsohavereasontowishtobefirstas 74 dorunnersonbanksandonassetsinbusts. TheshtickisoftenassociatedwiththeFrenchcartooncharactersAlphonseandGaston.See,e.g.,this 75 portrayal:http://en.wikipedia.org/wiki/Alphonse_and_Gaston.(ThankstoBobShillerforfindingandsendingthe image.)ThesituationisalsoreminiscentofthatposedbytheapocryphalKansasstatutereportedinProssers canonicalcasebookonthelawoftort:Thestatutepurportedlyrequired,ofanytwotrainsnearingeachother fromopposeddirections,thateachtrainstopandawaittheotheronespassage.

17

mostformidableofthese.DoingsorendersallthemoreclearwhythePlansketchedbelowis sourgentlynecessary. Thefirstadditionalimpedimenttoplenarymortgageloanmodification,then,stems fromthesecuritizationarrangementspursuanttowhichmostcontemporarymortgageloans arenowheldarrangementswhich,weshallsee,areaccordinglythefirsttargetsofthePlan weproposebelow.Thefragmentationofownershipinterestsbothinpoolsofmortgageloans and,thereby,eventheindividualmortgageloansthemselves,rendersitimpossibleforcreditors toactinconcerttomodifyunderlyingloans.76Thereisnowayforthesehundredsofthousands ofpeopleeventofindoneanother,letaloneacttogether.Ineffect,mortgageloanpooling putsthetraditionalcreditorcoordinationproblem,endemictoallsituationsinvolvingmultiple creditors,onsteroids,ifonemayspeakinthecurrentvernacular. Theproblemisrenderedyetworsebypooltranchingstructuresthatcanplacesome poolparticipantsforexample,seniorandjuniortranchesatoddswitheachotherwherethe timingofmodificationisconcerned:thesocalledtranchwarfareproblem.77Andthisisnot eventomentionthefactthateachpoolholdsmultipleloans,eachdistinctoneofwhichwould havetobedealtwith,intheeventofimpendinginsolvency,bythefragmentedand fragmentedinterestholdingcreditors.78 Thesecondadditionalimpedimenttoplenaryloanmodificationlikewisestemsfromthe securitizationarrangementsthatproliferatedduring,andindeedhelpedtofuel,therealestate bubble.Becausesecuritizedcreditorsaretoodispersedtoactinconcert,asjustnoted,the poolingandservicingagreements(PSAs)pursuanttowhichmortgageloansareaggregatedvest authoritytocollectloanpaymentsinasinglecollectiveagenttheservicer,typicallyabanking institution.ButthesamePSAstermsoftenflatlyprohibit,orotherwisestrictlylimitfor example,throughsupermajorityconsentrequirementsservicersfrommodifyingpooled loans.79Theyalsoprohibitorlimittheirsellingsuchloans.80Sotheonepartyexplicitlyvested
76 Intheory,ofcourse,indenturetrusteesandservicersarechargedwiththetaskofactingonbehalfofthe dispersedcreditors;butaswillbecomeapparentbelow,thePSAspursuanttowhichsecuritizationtrustsare formedtypicallylimittheseagentscapacitiestodowhatneedsdoingrightnow.Seeinfra,nextseveral paragraphs.SeegenerallyHockett,SixYearsOnandStillCounting,supranote3. Id. 77 Id. 78 79 Id.SeealsoOfficeoftheComptrolleroftheCurrency,OfficeofThriftSupervision,MortgageMetric ReportforThirdQuarter2008(2009);OfficeoftheComptrolleroftheCurrency,OfficeofThriftSupervision, MortgageMetricReportforFourthQuarter2008(2009);OfficeoftheComptrolleroftheCurrency,OfficeofThrift Supervision,MortgageMetricsReportforFirstQuarter2009(2009).Theseandadditionalreportsareavailableat http://www.occ.treas.gov/publications/publicationsbytype/otherpublicationsreports/indexmortgage metrics.html.SeealsoTomaszPiskorskietal,SecuritizationandDistressedLoanNegotiation:Evidencefromthe SubprimeMortgageCrisis(2010),ChicagoBoothSchoolofBusinessResearchPaper,No.0902,availableat

18

withcollectiveagencytoactonbehalfofourfragmentedcreditorsandtheirfinancialwellbeing iscontractuallyimpededfromtakingtheoneactionthatismostneedfulrightnowforthe creditorsthemselvesexpectedvalue(EV)maximizingprincipalreduction. AdistinctbutrelatedobstaclehereisthatPSAsalsodeterminethecompensation arrangementspursuanttowhichservicersarepaid.Andthesearrangements,madeduringthe boomyearswithnoevidentthoughtthatapropertypricebubble,bust,orconsequentdefault andforeclosuretsunamimightoccur,overwhelminglyplaceservicercompensationincentives atvariancewithlendersandborrowersvaluepreservingloanmodificationinterests.81 Inthevicinityofborrowerinsolvency,RMBSservicerfeesgenerallyareindependentof borrowerpayments.Theupshotisthatservicersoftenfarebetterfinanciallyovera12to18 monthperiodofborrowerdefaultthanoveranycomparableperiodofdebtrenegotiation, restructuring,andpaymentresumption.Meanwhile,(1)theaforementionedfragmentationof securitizedresidentialmortgageinvestors,and(2)counterpartdispersion,accompaniedby missinginformation,demoralization,andweakbargainingpoweronthepartofborrowers, conspiretoimpedeanyspontaneousdevelopmentofmoreincentivealigningservicer compensationarrangements.82

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1321646;JohnP.Hunt,WhatDoSubprimeSecuritization ContractsActuallySayAboutLoanModification?PreliminaryResultsandImplications,March25,2009,working paper,availableathttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=1369286;andCreditSuisse,TheDayAfter Tomorrow:PaymentShocksandLoanModifications(2007). Id.Hence,incidentally,oneoftheattractionsoflegallymandatedsalecompensatedtakingunder 80 eminentdomainauthorityasproposedinfra,SectionIII. See,e.g.,sourcescitedsupra,note79.SeealsoLarryCordelletal,TheIncentivesofMortgageServicers: 81 MythsandRealities,FinanceandEconomicsDiscussionSeries,DivisionsofResearch&StatisticsandMonetary Affairs,FederalReserveBoard,Washington,D.C.,No.200846(2008),availableat http://www.federalreserve.gov/pubs/feds/2008/200846/revision/200846pap.pdf;andSarahBloomRaskin, PuttingtheLowRoadBehindUs,RemarksattheMidwinterHousingFinanceConference,ParkCity,Utah, February11,2011,availableat http://www.google.com/imgres?imgurl=http://www.federalreserve.gov/aboutthefed/bios/board/bloom_raskin_s arah_web.jpg&imgrefurl=http://www.federalreserve.gov/aboutthefed/bios/board/raskin.htm&h=201&w=176&sz =57&tbnid=sicY7NccRVY5gM:&tbnh=104&tbnw=91&prev=/search%3Fq%3DSarah%2BBloom%2BRaskin%26tbm%3 Disch%26tbo%3Du&zoom=1&q=Sarah+Bloom+Raskin&hl=en&usg=__Jt7XFwpo3QK80uc0jC3_8dHDcP0=&sa=X&ei =70QfTtbPFsnb0QGInpS1Aw&ved=0CDUQ9QEwAw. 82 Seesourcescitedid.,aswellasHockett,SixYearsOnandStillCounting,supranote3.Itisinterestingto note,bywayofcontrast,thatinthesecuritizedcommercialrealestatemortgagemarketthesizesofindividual loansinthepoolsappeartohaverenderedlendersandborrowersmoreactiveinnegotiatingmoreincentive aligningservicercompensationarrangements.Heresecuritizedcommercialloanservicersdivideintotwo specialtiestransactionprocessorsandlossmitigators,withdelinquentloanpaymentstriggeringshiftsin responsibilityfromtheformertothelatter.Thelatter,inturn,arepaidinproportiontorestructuredloan performance,ratherthanintheformoffeesthatareindependentofsuchperformance.SeeagainHockett,Six YearsOnandStillCounting,supranote3.

19

Anotherdistinctbutrelatedpointisthattheresidentialrealestateloanservicing industry,whosepersonnel,practices,andtechnologiesalsowereretainedduringtimeswhen theprospectofsystemwidebustandforeclosurewerenotcontemplated,hassimplybeen overwhelmedbythesheermagnitudeofthebust.Neitherthenumbersandspecializationsof personnel,northetechnologiesbywhichdocumentsaremaintainedandretrieved,havebeen equippedtorespondtothescaleoftheproblemwerenowlivingwith. Thisissowhetherthescaleinquestionbemeasuredinnumbersofloans,amounts owedonloans,ornumbersofheterogeneousPSAscarryingdistinctsetsoftermsand requirementswithwhichservicersmustcomply.Itisultimatelythiscircumstancethat accountsboththeaforementionedrobosigningscandalsoftwoyearsago,andthe recommendationofsubservicerarrangementsforstilltroubledloansintherecently proposedsettlementbetweenBankofAmericaandanumberofinstitutionalinvestors.83 Thethirdadditionalimpedimenttoplenaryloanmodificationstemsfromasurprising turntakenbythefamiliardivergenceofinterestbetweenfirstandsecondlienholderson mortgageloans.Itturnsoutthatsecondspossesssignificantholduppoweroverwouldbe valuepreservingmodificationarrangementsbetweenborrowersandfirsts,notwithstanding theirsubordinatestatustothosefirsts.Thispoweroperatesthroughanotherpowerthat secondsinturnholdoverborrowers. Inessence,theproblememergesfromtwoconjoinedfacts.84Thefirstisthatfirsts evenwhenabletoactinconcert,orwhennothavingtodosobecauseholdingsingleportfolio loansdonotbenefitbyloanmodificationunlesssecondsmodifytoo.Thisissimplya consequenceofthefamiliarobservation,sometimesmadeinconnectionwithtranchwarfare situationsofthesortmentionedabove,thatcreditorsinthefirstlosspositionlikewiseare firsttobenefitbyprincipalreduction.Thesecondoperativefactisthatsecondsreapgreater benefitbynotagreeingtomodifications,thankstoapowertheyholdoverdistressed mortgagorsinvirtueofthelattersliquidityneedswhenfinanciallystrapped.85 Asqueezedborrowerwhocannotaffordtomakeallpaymentsrequiredofherinagiven month,andwhomustaccordinglyfallbehindonsomething,willtypicallyfallbehindfirstonher
83 See,e.g.,Goodman,supranote61,formoreonthebustsoverwhelmingofservicers.AlsoHockett,Six YearsonandStillCounting,supranote3.Note,inadditioninthisconnection,thecontrastwithservicing arrangementsinthecommercialrealestatemortgagemarkets,asdescribedsupra,note82.TheBankofAmerica settlementisavailableathttp://www.cwrmbssettlement.com/docs/Exh%20B.pdf. 84 SeeAlpert,Hockett,&Roubini,TheWayForward,supranote22.AlsoHockett,SixYearsOnandStill Counting,supranote3. Seesourcecitedsupra,note83. 85

20

firstratherthanhersecondmortgageloan.Thereasonisthatdefaultonthelattertypicallya homeequitylineofcredit(HELOC)meanslossofcapacitytopayforanythingelse,including thethingsshemustpurchasetoliveandtoworkwhileendeavoringtodigherselfoutofdebt. Defaultontheformer,bycontrast,triggersalengthyforeclosureprocessthataffords breathingroominwhichtoattempttoputlifebackinorder.86Hencesecondshaveboth holduppowerandincentivetoexerciseit,whilefirstsandtheirborrowersareunabletobenefit bythemodificationthatbothneedandwantuntilsecondsstopwieldingthatpower. Whatislegallyperversehere,ofcourse,isthatsecondlienholdersineffectcanuse powertheyholdovermortgagorstoseizeprioritystatusfrompriormortgageesfirst lienholders.Insodoingtheycanpreventvaluepreservingloanmodificationsevenbyportfolio lenderswhoarenotfacedwiththeextracoordinationchallenges,describedjustabove,that RMBSinvestorsface. Sincesome$873billioninsecondlientermmortgagesandHELOCmortgageloans,most ofthemseconds,weighonalargeportionofthemostdeeplyunderwaterfirstmortgageloans nationwide,thisimpedimentisparticularlycostly.87InoursamplerepresentativeCounty, moreover,thisproblem,likemostofthestatesandthenationsmortgagerelatedproblems,is proportionallyworse.HELOCsinSanBernardinoamounttosignificantportionofmortgage debt.88 Butthereismorehere.Ironically,theservicerincentiveproblemmentionedamoment agodovetailswiththeHELOCholdupproblem.Why?Becauseinmanycasestheserviceritself istheHELOCsecondlienholder!89Thereisaccordinglyaconflictofinteresttobuttressthe aforementionedPSA,compensation,andoverwhelmednessimpedimentstoservicers agreeingtoloansalesorprincipalreductions.Againstthisbackdrop,thelackofplenary principalreductionsofthesortthatwouldendourongoingandstillselfworseningmortgage crisiscouldhardlybelesssurprising. Butwait,onemightnowinterject,whataboutthefederalHomeAffordableMortgage Program(HAMP)andtheHomeAffordableRefinanceProgram(HARP)?Andhowaboutthe loansheldbythegovernmentsponsoredentities(GSEs)FannieMaeandFreddieMacandthe MBSheldbytheFederalReserveSystemthrough,forexample,theNewYorkFedsMaiden Lanefunds?Arethesenotsignificantsitesofpotentiallyhelpfulfederalinterventionthrough
86 87 88 89

Seesourcecitedsupra,note83. SeeAlpert,Hockett,&Roubini,TheWayForward,supranote22. Figurestocome. SeeGoodman,sourcescitedsupra,note61.

21

whichprincipalmightbewidelywritdown?Canthefederalgovernmentnotact,bydintofits multipleconcentratedownershipstakes,asthatcollectiveagentwhichisevidentlyrequiredto solvethatthusfarintractablecollectiveactionproblemwhichisourongoingandstillself worseningmortgagecrisis? Alas,itseemsnotatleastnottotherequisitedegree.Thereasonsareonceagain many.ThemosttenaciousisprobablytheideologicallydividedU.S.Congress,90combinedwith thefactthatthefirstcostsandimmediateurgencyofournationsselfworseningmortgage crisisareexperiencedmoredirectlybythelocalitiesinwhichmortgagedpropertyislocated thanbythemoreremotelylocatedfederalgovernment.91Thesefactsalonerenderthefederal governmentunlikelytopurchasepossessionofmortgageloansoutrightwithaviewto restructuringorrefinancingthem,oreventorefinancethosetheyalreadyhold.Butthereisyet moretothestory. Itistruethatsomefederalinstrumentalitiesalreadypossesslargepoolsofmortgage loansorassociatedsecuritiesinsuchmannerasmighthelpenablerestructuring.The aforementionedFedfundsofcourseholdsome.Buttheserepresentonlyafractionofallsuch outstandingandhaveinanyeventbeenheldfromthestartwithaviewnottoholdingthem indefinitely,butinsteadfortheshorttermuntilmarketsrecover.Thepurposefromtheoutset hasbeentoaddressliquiditycrisesfacedbyanumberoflargefinancialintermediarieswhose balancesheetswerewidelybelievedtoholdunsustainablequantitiesoftoxicassetsin2008. Thatlimitedpurposeinturnlimitedthekindandquantityofassetspurchased,andofcourse alsoiswhytheFednowissellingthemoffataprofit. FannieandFreddiecouldhavebeenandstillmightturnoutbeasomewhatdifferent story.TheGSEsdoholdsignificantnumbersofloansforwhichtheycouldintheorywritedown principal.Theprincipalholdupsinthiscaseappeartobethree,twoofthemapparentlyrooted inonesource.ThefirstisthatFannieandFreddiethemselvesusethousandsofdistinct servicerstoservicetheloansthattheyhold,meaningthattheoverwhelmedservicer
90 Onemightpartlypunherebysayingthatthereisyetanothercollectiveactionprobleminthiscase, sincethedeeplydividedCongressissimultaneously(a)evenlydividedand(b)operatinginitsSenatesubjectto supermajorityvotingrequirementstheclassicrecipeforgridlock. Firstcosts,immediateurgency,andmoredirectlybecausethefirstcostsaretheforeclosures, 91 attendantevictions,propertyvalueandattendantrevenuebasedeclines,andlikeharmselaboratedmorefully infra,SectionsIIIandV,whichaffectedlocalitiesexperienceunmediatedafactwhichwillfigureintothe justificationofrecoursetomunicipaleminentdomaininfra.Latercostsexperiencedbythenationatlargeare mediatedandlessdirectbecausetheyinvolveradialeffectsofmortgagedebtoverhangandforeclosureon consumerspending,growth,andemploymentinthemacroeconomycostswhichsomemembersofCongress evidentlydonotrealizestemmorefromtheongoingmortgagecrisisthan,say,fromwomensuseof contraceptivesorthePresidentsbirthcertificate.

22

impedimentmentionedabovecouldproveoperativeheretoo.Butthisistheleastseriousof theGSEholdups. ThesecondholdupisthatmanyunderwaterGSEloanssomewhereontheorderof 50%aresubjectalsotosecondliens,meaningthatFannieandFreddiealsofacetheHELOC obstaclenotedabove.Weretheyortheirregulatorand,forthetimebeing,conservatorthe FederalHousingFinanceAuthority(FHFA)toplayhardballwiththesecondlienholders, principalwritedownsmightbesomewhatmorecommon.Butthecurrentactingdirectorof theagencyseems,forthetimebeingatleast,toberatherreluctanttostrongarmthe bankinginstitutionsthatholdthesesecondliens.92

92 Therearesomeverytentativesignsthatthiscouldchange,inlightofthepresentactingdirectorsrecent remarksmadeattheBrookingsInstitutionandhisJanuarylettertoCongressmanCummingscitedimmediately below,totheeffectthatFHFAisassessingtheprospectofprincipalreduction.Weresuchchangetooccur,Fannie andFreddiecouldpossiblyprovetobehelpfulfederalcomplementstothemunicipalitiesonwhosebehalvesIam herearguingbydoingwiththeloansthattheyholdsomethinglikewhatSectionIIIprescribesthatthe municipalitiesdowiththeloanstheypurchasethroughcondemnationfromprivatelabelsecuritizationtrusts. Moreonthisinfra.ItalsobearsnotingherethatProfessorJacksonsproposal,supranote11,andtheauthors 2008proposalnotedinthesameplace,wouldhaveamountedtomeansverysimilartotheseforachievingmuch thesameend.InsofarasthecurrentactingdirectorofFHFAchangeshismodeofthinkinghere,then,hewillbe movinginthe2008JacksonandHockettdirections. Itisalsoimportanttonote,however,thattheprospectiveprincipalreductionsnowbeingassessedby FHFAwouldoperateintandemwithHAMP,meaningthattheywouldrequiresignificantincentivepaymentsby Treasury.Thatmeansboth(1)thatcurrentFHFAthinkingonprincipalreduction,wereittoissueinactualsuch reduction,wouldalsoentailsignificantexpensetothepublicfisc,and(2)thattheEVcalculationbyreferenceto whichthedecisionistobemadeisstackedagainstFHFAapprovalofprincipalreduction.Infact,inFHFAscurrent calculations,asregisteredatpp.1819oftheBrookingsaddresscitedimmediatelybelow,HAMPrequiredservicer incentivepaymentsmadebyTreasury($3.9billion)wouldbemorethandoubletheEVgainenjoyedbyFannieand Freddie($1.7billion).Allofthis,ifaccurate,suggestsboththatthepubliclycostlessPlanoutlinedbelowin SectionIIIisboth(1)justaboutinfinitelymoredollarwiseefficientthanHAMPhamperedprincipalreductionas currentlycontemplatedbyFHFA,and(2)infinitelymorelikelytooccuraswell. FortheBrookingsremarks,seeEdwardDeMarco,AddressingtheWeakHousingMarket:IsPrincipal ReductiontheAnswer?,RemarksDeliveredattheBrookingsInstitution,April10,2012,availableat http://www.brookings.edu/events/2012/0410_housing_demarco.aspx.Forthementionedletter,seeLetterfrom EdwardDeMarco,ActingDirectoroftheFederalHousingFinanceAgencytoCongressmanElijahCummings, RankingMember,CommitteeonOversightandGovernmentReform,January20,2012,availableat http://www.google.com/url?sa=t&rct=j&q=fhfa%20letter%20to%20cummings&source=web&cd=2&ved=0CDIQFjA B&url=http%3A%2F%2Fwww.fhfa.gov%2Fwebfiles%2F23056%2FPrincipalForgivenessltr12312.pdf&ei=xap_T8TCGJ Ph0wH7_rT4Bw&usg=AFQjCNF958kOhlVkOCBFW3rKmicBnBvd1g. NotefinallythatAlpert,Hockett,&Roubini,TheWayForward,supranote22,andLaurieGoodman, sourcescitedsupranote61,offerhelpfulmeansofavoidinganyriskofprincipalreductioninducedmoralhazard ofthesortwithwhichFHFAmightbeconcerned.(See,e.g.,concernsnotedatpage19oftheBrookingsRemarks.) TheFederalReserveandFRBNYPresidentBillDudley,supranote8,alsoendorsesuchreadilyavailablemeansof hazardmitigation.Finally,seealsoHUDSecretaryDonovansrecentinterventionsonthissubject,e.g.,Housing SecretaryPushesMortgageWriteDowns,REUTERS,April6,2012,availableat http://www.reuters.com/article/2012/04/06/ususahousingidUSBRE8350MS20120406.

23

ThethirdreasonthatFannieandFreddiedonot,atleastyet,engageinsignificant principalwritedownslikewisetakesrootinthepresentwayofthinkingofthecurrentacting directorofFHFA.Thethinkinginthiscaseisapparentlythat,becauseFHFAaspublic conservatoroftheGSEsmustsafeguardtheirassetstosafeguardthefisc,writingdown principalonGSEheldloanswouldcompromiseitsstatutoryduty. Thisisofcoursesoundthinkingonlyifwritingdownprincipalonunderwaterloans eitherlowerstheEVsoftheloans,orentailscoststhatexceedEVbenefits.If,bycontrast, writingdownprincipalsignificantlylowersdefaultriskwhichitdoesandtherebyincreases EVsbymorethanwhateveradministrativeorothercostswouldbeentailedbythewrite downs,thelongtermfiscpreservationmissionisactuallybettereffectedbywritingdown principal.Thatopensaninterestingdoor. Itshouldbenotedatthisjuncturethatthelikelihoodofprincipalwritedowns increasingtheEVsofparticularloansincreaseswiththeaggregatenumberofwrittendown loansacompositionalcorollaryofthefirst,deepstructuralcollectiveactionimpedimentto privatelymanagedprincipalwritedownsnotedabove.93ButthismeansthattheactingFHFA directorspresentwayofthinkingismoresoundinsofarastheGSEsandanyentitiesthatmight coordinatewiththemcollectivelyholdfewerloans,andlesssoundinsofarastheGSEsandany entitiesthatmightcoordinatewiththemcollectivelyholdmoreloans.Suchcoordinating entitiesmightinclude,ofcourse,municipalities. Thecurrentactingdirectorsrecentacknowledgementthatprincipalwritedownsat leastmightultimatelyprovetobeinthepublicsinterest,asnotedaboveinnote92,is accordinglyverywelcome.ForitsignalsthatmunicipalitieseffortspursuanttothePlanwe elaboratebelowinSectionIIImightultimatelybeenhancedbydiminishedGSEpassivity.The GSEscoordinatingwithmunicipalities,orevenconveyingtheirunderwatermortgagestothem forfairmarketvalue,wouldeffectivelymagnifythedegreeofcollectiveagencyexercisableby governmentinstrumentalitiesinmodifyingunderwatermortgageloans.Thatwouldinturn maximizesystemwideEVsandminimize,ifnotindeedeliminate,costtothefisc. Itwillbehelpful,then,assuggestedaboveinintroducingthisMemorandumandaswe shallseemorefullyverifiedpresently,tothinkoftheGSEsaspotentialcomplementstostate
93 Asnotedabove,thelasttowritedownprincipalhasleastreasontowritedownprincipalowingtothe appreciationofhomepricesinresponsetothelesseneddefaultrisksystemwidewroughtbyothersprincipal writedowns.Thisisacompositionalwholegreaterthanthesumofitspartsphenomenon,moreextreme versionsofwhicharethosemarketwideaggregateovervaluationsknownasbubblesandmarketwideaggregate undervaluationsknownasbusts.SeeagainHockett,AFixerUpperforFinance,supranote5;Hockett,Recursive CollectiveActionProblems;supranote6;andHockett,Bailouts,BuyIns,andBallyhoo,supranote72.

24

municipalitiesinsolvingthatongoingcollectiveactionproblemwhichistheselfworsening mortgagecrisis.Forwhenthemunicipalitiesbegintemporarilypurchasingmortgageloansand writingdownprincipalpertheMunicipalPlanelaboratedbelow,totalpublicholdingsof underwatermortgageloanswillbeallthegreater. TheactingFHFAdirectorwillthenhavelittleremainingreasontosupposethattheGSEs joiningintowritedownprincipalwillhaveanybutsalutaryeffectsonthefisc.Indeedhemight wishtoconveyGSEheldloanstothemunicipalitiesthemselvesassuggestedabove,inviewof theMunicipalPlansavoidanceofanypublicexpenditureafeaturethatevenGSEwritedowns underthecurrentregimewouldnothaveinoperatingintandemwithHAMP,towhichweturn next. HowaboutHAMPandHARP,then?Aretheynotprogramsthatinvolvecollective agencyatthefederallevel,suchascansolvethosecollectiveactionchallengesthatunderwrite ourongoingandselfworseningmortgagemarketslump?Alas,notreally.Herewearebackto impedimentsthatsoundlessindeepstructuralchallengetocollectiveactionandmorein contractualandpoliticalsuchchallenges,alongwithcertainprogrammaticlimitations. TobeginwithHARP,heretheprincipalproblemtakestheformofprogrammatic limitation.HARPsimplyisnotthereforprincipalreduction.Itsaninterestreductionprogram forGSEheldloans.Thatcanbehelpful,ofcourse,justascanbridgeloanassistanceofthesort mentionedearlier.Butitisnotdesignedtoaddressthecoreproblemwhichis,again,the urgentneedofprincipalreduction. HAMPforitspartencouragessomeprincipalmodificationand,moreso,lessambitious formsofloanmodification.Thisitdoespursuanttothesocalledwaterfallsequencing,which reliesfirstoninterestreduction,thenontermextension,thenonprincipalforbearance,andas alastresortonprincipalforgiveness.HAMPhas,moreover,evencomeincreasinglyto contemplateprincipalreductionsince2010throughthethenintroducedPrincipalReduction Alternative(PRA)forwhichTreasuryrecentlyhasannouncedanintentiontotripleincentive paymentsmadetocreditorswhooptforit. Theproblem,however,isthatbecauseHAMPdoesnotinvolveanycollectiveagents actuallytakingpossessionofloans,itcontinuestobehampered,ifonemightbepardoneda pun,bythelastseveralimpedimentslistedabove.Italsooccasionscoststothefiscthatare notonlyregrettableinthemselvesifavoidable,butalsoproblematicforpurposesofGSE soughtprincipalreduction.Again,inotherwords,weseeinterlockingandmutualreinforcing amongthemanyimpedimentswemustcatalogue.Wesketchtheproblemsinturn.
25

 First,then,HAMPcannotbringfragmentedpartiesininteresttogetheranymorethan thosepartiesthemselvescanfindoneanotherandsurmounttheirconflictsofinterest.Second, itcannotreadilyundoPSAunanimityorsupermajorityrequirementswherethosearepresent. Third,itcannotreadilyundocontractuallimitationsonservicerswritingdownprincipalor sellingoffloans.Andfourth,itcannotseemtohandlethesecondlienproblem,particularlyin viewofthefavorabletreatmentthatHAMPsSecondLienModificationProgram(2MP)affords secondsattheeffectiveexpenseoffirsts.Inthesesenses,HAMPsuffersalltheimpedimentsto partiesthemselveswritingdownprincipalcataloguedabove. WhatcanHAMPdowell,then?Allitcandowellistoaddressoneoftheservicer incentiveproblemsnotedabove.Thatishelpful,ofcourse,onlyforloansthatdonotsufferthe aforementionedcontractualprohibitions.Moreover,andmoredamning,theonlymethodthat HAMPhastoaddresstheservicerincentiveproblemistobribetheservicers.Thisitdoesinthe formofpaymentsofthePRAsortnotedabove. Inotherwords,HAMPworks,whenitworksatall,throughmeansthatinvolve significantpublicexpenditurewhich,againasweshallseebelow,thePlanweproposehere doesnot.AndthiswillremainthecaseevenshouldGSEsbeginwritingdownprincipalin conjunctionwithHAMPasnotedaboveandinnote92.Thatmightaffordyetmorereasonfor GSEsthemselvestogotherouteofthePlanweproposehereinSectionIII,byconveyingtheir underwaterloanstomunicipalitiesforfairmarketvalue,andperhapsevenparticipatinginthe financingoftheseacquisitions,likePLSTsandinvestorsthemselvesasdescribedbelow. NoneofthisistodenigrateHAMPorHARP,whichhaveenjoyednotablesuccessesand evenhavemarginallyincreasedtherateatwhichtheyaremanagingtosecureprincipal reductionsontroubledloansinthecaseofHAMP,andmarginalforeclosurepreventionthrough refinanceinthecaseofHARP.Itisonlytosaythattheseprogramsareunnecessarilycostlyand inherentlylimitedbythebaroquemethodologiestheyemployorprogrammaticrestrictionsto whichtheyaresubjectwhereaddressingtheunderwatermortgagecrisisisconcerned. Theycanhelpsignificantlyalbeitattaxpayerexpensewithmortgagesthatarenot underwater.AndHAMPforitspartcaneveninduceprincipalreductionsatyetheftier taxpayerexpenseinthoserelativelyfewcaseswherePSAsandservicerconflictsdonotstand intheway.Butinthesecapacitiestheyareatbestmarginalcomplementstoabonafide principalfocusedstrategy.Weshallseeshortlythatonlymunicipalitiesarewellsituatedto embarkonthatstrategy.
26

 These,then,aretheprincipalimpedimentsthathavestoodintheway,andstillstandin theway,ofseniorandjuniorfirstlienholders,secondlienholders,borrowersandeven servicerswhomightotherwisehaveactedinconcertbynowtomodifymortgageloanssoasto renderthempayable,eliminatedebtoverhang,andmaximizesalvageablepostbubble mortgageandcollateralvalueforall.Therehave,tobesure,beenadditionalpotential impediments.TheseincludeprovisionspromulgatedundertheInternalRevenueCode(I.R.C.) until2009,94accountingstandardspromulgatedbytheFinancialAccountingStandardsBoard (FASB)asof2008,95andpossiblytheTrustIndentureAct(TIA)of1939,althoughthelatterhas notbeenlitigated.96Butbecauseallofthesewouldhaveservedsolelyasfallback

94 Sections860Athrough860GoftheIRC,asinterpretedbytheInternalRevenueService(IRS)underits RevenueProceduresandTreasuryRegulationsatleastuntilSeptember2009,conditionedthepassthroughtax treatmentofthoseRealEstateMortgageInvestmentConduits(REMICs)thatholdsecuritizedmortgagesupon strictpassivity.Modificationsofunderlyingmortgageloans,fortheirpart,weretreateduntilrecentlyas departuresfromtherequiredpassivity.Hencesecuritizedmortgageobligationsuptothatpointcouldbemodified onlyonpainofsignificantbacktaxpenalty.ChangesmadebytheIRStothetextofitsRevenueProcedures(see Rev.Proc.200945)andTreasuryRegulations(seeSection1.860G2)inmidSeptemberof2009,however,which applyretroactivelytoearly2008,havearguablyremovedthiserstwhileimpedimenttoloanmodification.That wastheintention,atanyrate.SeeHockett,SixYearsOnandStillCounting,supranote3.Intheabsenceofany realcapacityonthepartofMBSholdersactuallytofindoneanotherandworktogetherwithmortgagorstomodify underlyingloans,however,thissalutarychangetothetaxrulesisforpresentpurposesunhelpful.SeeHockett,Six YearsOnandStillCounting,supranote3. Foraloanoriginator,whotypicallycontinuesonasaservicer,torealizeagainonthesaleofaloantoa 95 REMICtrustandremovetheloanformitsbalancesheetasitaimstodo,thetrusttowhichitsellstheloanmustbe qualifiedundertheaccountingstandardsaspromulgatedbytheFinancialAccountingStandardsBoard(FASB) andemployedbytheSECinitsregulatoryroles.Thisinturnlegallyrequiresthattheoriginatorretainnocontrol overtheassets.SeeAccountingforTransfersandServicingofFinancialAssetsandExtinguishmentsofLiabilities, StatementofFin.AccountingStandardsNo.140,Paras.813(FinancialAccountingStandardBoard2008). Although(a)thestandardsdonotelaborateonwhatcountsascontrol,and(b)someSECstaffhave opinedthatmodificationsofimminentlydefaultingloansprobablywouldnotcountascontrolofthesortthat wouldshiftassetsbacktooriginator/servicerbalancesheets(seeLetterfromChristopherCox,SECChairman,to Rep.BarneyFrank,ChairmanofComm.onFin.Servs.,USHouseofRepresentatives(July24,2007)),thereis sufficientuncertaintyonthematterastorendertheavoidanceofmodificationprudentintheeyesofcautious originator/servicers.Asinthecaseofthetaxprovisionsdiscussedsupra,note94,however,itisnotclearthatthis sourceofuncertaintyisdecisive,giventhealreadyformidabletaskwouldbeloanmodifyingprincipalswouldface inattemptingtofindoneanotherandthenactinconcertwithmortgagorstorestructureunderlyingloans.See againHockett,SixYearsOnandStillCounting,supranote3. Thoughthequestiondoesnotappearevertohavebeenlitigated,thetermsoftheTrustIndentureActof 96 1939,15U.S.C.Sec.77aaa77bbb(TIA),whichapplytoallcorporatebondsincludingresidentialmortgagebacked securities(RMBS),wouldseemtorequireunanimousconsentamongbondholdersbeforerightstoreceive principalandinterestpaymentsonthesecuritiescouldbealtered.Thatinturncouldbeexpectedtooperateasan impedimenttomodifyingthetermsofunderlyingmortgageloansassuming,asseemsplausibleenough,that suchalterationswouldresultinalterationstopaymentsintothelegalentityonwhosebehalftheservicercollects onunderlyingmortgagesbeforedistributingproceedstoRMBSholders. Thiswouldbesoevenweremodificationstounderlyingloansdemonstrablytoimproveexpectedvalue. FortheTIAsrequirementsarecategorical,whileactuallysecuringthecategoricallyrequiredexpressunanimity amongthousandsormillionsofRMBSholdersworldwideissohighlyimprobableastoamounttoimpossibility. Whileitisnotcleartowhatextent,ifany,theTIAcurrentlyfiguresintothethinkingofservicersandtrust

27

impedimentsbehindthemorefundamentalandmoredirectobstaclestojointcoordinationjust catalogued,97anyplanthatmightsubstituteforinterestedpartycoordinationwilleffectively sidestepallimpedimentstoloanmodificationandrevaluation.Thatispreciselywhatthe MunicipalPlandoes. III.TheMunicipalPlanStructureandOperationalDetails Wenowturntothemaineventthecombinedcondemnation,compensation,and mortgageloanmodificationPlanbestabletoendthestilldragging,selfworseningmortgage foreclosurecrisislaidoutandstructurallycharacterizedabove.ThisSectionlaysoutthePlans fundamentalattributesandfinancialfeatures.ThefollowingSectionlaysoutitslegalcontours andconstitutionalunderpinnings. TheMunicipalPlanisdesignedspecificallytosidestepalloftheunnecessary impedimentsthatpresentlyblockmeaningfuldebtrevaluationandattendantvalue maximization.Itdoessobyforthrightlyrecognizingthechallengeforwhatitis,thenaddressing itaccordingly. Thechallenge,again,iseffectivelyanenormouscoordinationproblemfacedbyliterally hundredsofthousands,ifnotindeedmillions,ofdispersedinterestedparties.Eachofthese partiesactingindividuallyhasgoodreasontowaitfortheotherstoact,andsothegroupasa wholefailstoact.Further,evensuchpartiesasmightneverthelesswishtoactwouldbeunable tofindoneanothertoact.Contractrigiditiesandincentivesthattrustees,servicersandsecond lienholdersfacedrivethefinalnailsinthecoffin. Thereisnooneasyetwhohasprovedwillingandabletoactinamannerthatbenefits allofthesefragmentedpartiesininterest.Nofederalprogramsorinstrumentalitiesare properlyequipped,letalonecarefullyaimedatthecoreproblem. Entertheoneinstrumentalitythathasnotbeenconsidered.Werefertothestatesand theirmunicipalitiestownships,cities,counties,andkindredunitsoflocalgovernment.By

administratorsintriguedbytheprospectofvaluesalvagingmortgagemodifications,giventhemanymore conspicuousfactorsalreadycitedthatservetodissuademodification,itsurelycouldpresentanobstaclewere thoseotherobstaclestoberemoved.SeeHockett,SixYearsOnandStillCounting,supranote3.Thisofcourse affordsyetmorereasontoactpursuanttothePlanelaboratednext,inSectionIIIofthisMemorandum. 97 SeeHockett,SixYearsOnandStillCounting,supranote3,foracompletecatalogueofallimpediments,as wellasflowchartformtracingoftheirmultiplemutualinteractions.AlsoAlpert,Hockett,&Roubini,TheWay Forward,supranote22.

28

actinginthenameofitsresidents,theirsafetyandwellbeing,anditsowneconomicnecessity aswellasinamannerthatcollaterallybenefitsalldispersedcreditorswhowouldratherbepaid thanforeclosetheAmericanmunicipalityisideallypositionedtosolvethatstillworsening, valuedestructivecoordinationproblemwefaceinourmortgagemarkets.Fortheproblem itselfisessentially,initsfirstinstance,localincharacter. Itisarealestatecrisiswearelivingwith.Andithasbeenallalong.Thatmeansitisa localcrisisbeforeitsanationalone.MainStreetswoesaretheultimatesourcebothofWall Streetsandofthewidereconomyswoes. Itiscitiesthatmustwatchtheirresidentsbeingevicted,theirhomesbeingemptied, theirhousesdeteriorating,theirpropertyvaluesplummeting,theirtaxbasesdwindling,their servicesretrenching,theircrimelevelsspiking,andsoonandon.Buttheydonthavetolie backandwatch.Theycanact,andactnow.Theyexisttoaddressproblemslikethese. Protectingthecitizenryandheadingoffblightiswhatmunicipaleminentdomainauthorityis for.Itswhywehaveit.Anditswhymunicipalities,ratherthanstatesdirectlyorthefederal government,arethoseentitiesthatmostoftenemployit. ThePlangrowsfromthissimplefact.Itisaccordinglyformunicipalities,orjointpowers authorities(JPAs)thattheyortheirstatesestablishtoenablecoordinationamongmultiple municipalities,todischargetheirlegallyappointedfunctionbycustomary,legallyfamiliar means.Anditisforthemtodosoinpartnershipwithprivateinvestorswhoeffectivelyrender thePlanpubliclycostlessjustaswevedonesincetheearliestdaysofourrepublicincarrying outandfinancinglocalprojects. Hereishowitworks.Webeginschematically,thensteadilyfillindetail. Forpurposesofexpositionweshallagainassumeaparticularmunicipality.Againthat willbetheCaliforniacountyofSanBernardino,oraJointPowersAuthority(Authority)that SanBernardinoorCaliforniaestablishestofacilitatecollaborationamongmultiple municipalities.Now,inpartnershipwithlendinginstitutionsandemployingitstraditional eminentdomainpower,theCountyorAuthoritywillpurchase,atfairmarketvalue,temporary possessionofcarefullyselectedunderwatermortgageloansandliensonpropertieslocated withinitsjurisdictiontofacilitaterefinancethesame.98
98 ForreminderofwhySanBernardino,Californiamakesforanillustrativecasestudy,pleaseseesupra,note 54andaccompanyingtext.Wesaythatpossessionofthepurchasedmortgagesis,forthemostpart,temporary intwosenses.First,thepurchasedmortgagenoteobligationsandattendantmortgagessecuringthemare dischargedandextinguisheduponrepayment.Second,mostofthenewloansandattendantmortgagesthat replacetheantecedentonesareconveyedtonewtruststhatbecomethenewmortgagees.Themunicipalities,in

29

 Onceithaspurchasedpossession,theCountyorAuthoritywillworkdirectlywitheach willingmortgagorwithinitsjurisdictiontoacceptashortthatis,discountedrepaymentof thatmortgagorsobligations.Itwilldosoinanamountcorrespondingtothelevelatwhichthe mortgagorcanobtainnewfinancinginthecurrentmortgageloanmarket. Asmentioned,municipalitiesorauthorities,financedbyprivateinvestors,willpayjust compensationtocurrentloanandlienholdersinpurchasingtheselectloansandliens,as requiredbybothstateandfederallaw.99ApplicableCalifornialaw,whichdefinestheeminent domainauthoritysomewhatmorenarrowlythandoestheU.S.Constitution,100pegsjust compensationatwhatittermsfairmarketvalue.Thisitdefinesasapriceapttobereached bycounterpartiesbargainingatarmslengthunderorderlymarketconditions.101 MunicipalitiesorauthoritiesactingonthePlaninCaliforniaandcounterpartstates mightaccordinglysometimesbepayingmorefortheaffectedloansandlienseventhanmany privatemarketparticipantsthemselveswouldnowvaluethem,underthosestillselfworsening

otherwords,donotsimplybecomepermanentstatelevelcounterpartstotheGSEs.Apartialexceptiontothe generalcasehereisthecaseofanyborrowerwhomightultimatelyprovenonrefinancable,inwhosecasethe municipalityorjointpowersauthoritywillselltheloanonthewholeloanmarketinstatesthatpermitthis,while holdingtheminstatesthatdonot.(Californiapermitsitsmunicipalitiessuchsales,FloridaandNevadaatpresent donot.)Investorscollaboratingwiththemunicipalityorjointpowersauthoritybeartheriskinallcases,which,for reasonselaboratedthroughoutthisMemorandumandfurthersubstantiatedinAppendixA,issignificantlylower thanistheriskofwidespreaddefaultandattendantvaluelossinconnectionwithnonrefinancedunderwater mortgages. Thebasesonwhichmortgagesareselectedforacquisitionismorefullyelaboratedbelow.Theshort playingversionisthatthefirstselectedmortgagorsmustbecurrentontheirobligationshencegoodcreditrisks andoweonsignificantlyunderwatermortgageobligationshencestrappedbyseverepostbubbleconditionsthat theyhadnomorereasonthandidlenderstoanticipate.Somecommunitiesmightofcoursesubsequentlyselect mortgagespursuanttobroadercriteria,asdeterminedpertheirownlegislativejudgment.ThePlanis,inother words,sufficientlyadaptableastobefinetunedfromcommunitytocommunityinmannersresponsivetothose communitiesparticularneeds.Itshouldalsobenoted,ifonlyinpassing,thatmostmortgagessecuringreal propertydebtsinoursamplestateofCaliforniaareactuallydeedsoftrust.Forpresentpurposes,howeveror formostanyotherpurpose,forthatmatternopracticaldifferenceisintroducedbythisdistinction.See generally4WITKIN,SUMMARYOFCALIFORNIALAW:SECURITYTRANSACTIONSINREALPROPERTY,5at795(10thed.2005). Fairmarketvalue,whichisCaliforniaslegallymandatedunderstandingofjustcompensation,might 99 evenexceedcurrentmarketvalueinviewoftheongoingandstillselfworseningslumpwhosestructuraldynamics wehavecharacterizedaboveinSectionsIandII.Thisisonesenseinwhichcreditorsthemselvesbenefitbythe Plan.Seeinfra,notes101104,andassociatedtextformoreonthismatter.Alsoinfra,SectionIV. Cites. 100 SeeCal.Civ.Pr.1263.310and1263.320(a).Seeinfra,SectionIV,forfulltext.Fairmarketvaluewould 101 accordinglybehigherfor,say,apropertyjustoutsidethezoneofdangerdeemedbyauthoritiestosurroundThree MileIslandthancouldlikelybehadintheactualmarketforsuchpropertiespost1978.Bythesametokenitwould belowerfor,say,thelastpropertysoldontheoutskirtsofterritoryrecentlyannouncedtobeslatedforanew VandenbergAirForceBasethantheactualmarketassignedtosuchpropertyimmediatelyfollowingthat1950sera announcement.Moreonthesemattersinfra,SectionIV.

30

marketconditionsoutlinedandquantifiedabovethroughoutSectionsIandII.Forthese,recall, areconditionsthat,againforthereasonselaboratedinSectionII,bearnoinherenttendencyto change.Indeedtheyllcontinuetoworsenunlessanduntilmunicipalitiesorjointpowers authoritiesactperthePlanweelaborate.102 Itispreciselythisfactthefactthatconcertedactiontakenbythemunicipalitieswill,in solvingthecollectiveactionproblemsthatunderwritealloftheongoingillhealththatwefind inourmortgagemarketswhichaccountsforprivatemarketparticipantswillingnessto financethecondemnationsinthemannernexttobedescribed.More,then,onthat. MunicipalitiesorauthoritiesactingonthePlanwillpayforthemortgageassociated loansandliensofwhichtheytakelegalpossessionwithfundssuppliedbytheaforementioned privatesectorinvestinginstitutions.103Amongtheseinvestinginstitutionswhich,notably, mayincludecurrentloanandlienholdersthemselves,indirectlythroughMBS104willbeone ormoreofthefollowing:publicandprivatepensionfunds,insurancecompanies,mutualfunds andotherinvestmentfirms.105 InvestorsapttobeattractedbythePlanincludeinparticularsuchasmightwishto replacepresentlytroubledanddefaultpronemortgageloanswithsaferassets,eitherintheir ownportfoliosorintheportfoliostheymanageforothersinfiduciarycapacities.Assuggested aboveinSectionII,thatmightmeaneventheGSEsFannieandFreddie,whobyparticipating inthePlancanmaximizeportfoliovalueandfacilitateprincipalwritedownsinthepublic interestwithouthavingtomakeheftyHAMPPRAincentivepaymentstoservicers. Nowtothecondemnationprocessitself.

102 PreciselybecausecurrentconditionsarerootedincoordinationimpasseaselaboratedinSectionsIandII. Seeinparticular,inthisconnection,thestatisticselaboratedinSectionII. Whiletheprivatesectorinvestorswillinitiallybeactingaslendersofajointpowersauthorityorotheroff 103 balancesheetentityestablishedbythemunicipalitiestoreceivethecondemnedmortgageloans/liens,the transactionconstitutespartofaforwardpurchasebythoseinvestorsofnewmortgagesecuritiesthatwillcome forthpursuanttothePlansexecution.Thereisasensehereinwhichinvestorsareeffectivelypartneringwith municipalities.Theyaredoingsopursuanttoanarrangementinwhichthemunicipalitiesnowactinthenameof allinterestedparties,perthetermsofSectionsIandIIabove,asthatonecollectiveagentwhichisabletosolve thecollectiveactionproblemsthatallmortgagesecuritiesinvestorsandtheirobligorscurrentlyfacewhen contemplatingthedesirableprospectofvaluesalvagingloanrestructuring. Thisshouldnotbesurprising,giventherootednessofcurrentmarketundervaluationofthese 104 institutionsmortgageloanandlienholdingsinimpassiblecoordinationproblemsthattheyfaceandthe municipalitiesnowsolvesintheirname. Pleaseseesupra,notes101104.Alsoinfra,SectionIV. 105

31

Atthecommencementofplannedcondemnationproceedings,themunicipalitiesor authoritieswilldepositthementionedinvestorsuppliedfunds,asrequiredbystateseminent domainstatutes,instateadministeredescrowaccountsmaintainedforthepurpose.The depositedamountineachparticularcasewill,againasmandatedbylaw,besetequaltothe probablejustcompensationultimatelytobepaidforthemortgageloansandliensthatthe givenmunicipalitycondemns. UnderquicktakeeminentdomainproceduressuchasapplyinCaliforniaandmany otherstates,probablejustcompensationisdeterminedupfrontviamunicipalityprocured appraisals.Fundsthenaredepositedintotheaforementionedescrowaccountsatthetime thatthecondemnationmotionsarefiled.Oncefinalcompensationamountshavebeen subsequentlydeterminedbyloanandlienholdersandthecondemningmunicipalityeither withorwithoutcourtassistanceanyoverageleftintheescrowaccountswillbeequitably distributedamongloanandlienholders,donatedtoqualifiedhousingcharitiesthrougha programadministeredbyarespectednationaleleemosynaryfoundation,orboth. Onceunderwaterloansareacquired,eachmunicipalityorauthoritywill,incooperation withtheconsortiumofdesignatedparticipantsinthefinancialservicesindustrywhosupplythe upfrontfunding,ultimatelyacceptdiscountedrepaymentoftheloansfromqualifying mortgagorswhohaveoptedintothePlan.Repaymentoftheacquiredloansiseffectedbyre underwritingandrefinancingparticipatingmortgagorspursuanttocriteriacommonlyemployed byordinarymarketlendersandguarantorsliketheFederalHousingAdministration(FHA).This waythePlanensuresthatthenewloansareparticularlysafeandsound.106 Additionalsubstantiveeligibilitycriteria,atleastinthePlansearlystageswhenerring onthesideofcautionisprudent,areasfollows. First,thePlanwillapplyonlytosinglefamily,owneroccupiedresidenceswithineach municipalitysjurisdiction.Second,allexistingqualifyingfirstlienmortgageloanswillhaveloan tovalueratios(LTVs)greaterthan100%.Third,theaggregatefairmarketvalueofloansorliens securedbyanyqualifyinghomeistototalto85%orlessofthevalueofthehomeitself,as determinedbyquantitativevaluationmethodsdevelopedbythemunicipalitiesinpartnership withqualifiedmortgagefinanceprofessionals.107
106 Departurefromtraditional,andhistoricallyhighlysuccessful,FHAunderwritingcriteriawasahallmark,of course,ofthenotoriousnonprimeloansthatgrewpopularduringthefinalphaseofthebubble.SeeHockett, Bailouts,BuyIns,andBallyhoo,supranote72;alsoMORRIS,supranote52. PleaseseeAppendixA,below,fortechnicalspecifications. 107

32

Finallyfourth,thevalueofqualifyinghomeswillnotexceed105.3%ofFHAapproved loanamountsthuspermittinga95%newloantovalueratio.108Asithappens,oursample stateofCaliforniaisthesitusofjustunder1.5millionmortgageloansmeetingthesecategorical criteria.109 Otherstatesandmunicipalitieswillofcoursebethesitusofdifferentnumbersof mortgageloansmeetingthecriteria,andallstatesovertimewillpresumablyadjustthecriteria inkeepingwiththeirownlocalneedsandlegislativejudgments.Thisresponsivenesstospecific stateandlocalconditionsisindeedoneoftheparticularstrengthsofthePlan.Ratherthan requiringoneortwoentitieswithnationalscopetodealinonesizefitsalltermswith thousandsofservicers,pertheconcernsexpressedbyFHFAasnotedaboveinnote92,thePlan enableslocalitiesflexiblytotailorcriteriatovaryinglocalcircumstances,aswellastodealwith muchsmallernumbersoftrusteesandservicers,moreonwhichmomentarily. Alongwiththecategoricalcriteriajustelaborated,thePlancontemplatespossibleuseof severaladditional,somewhatmoreopenendedsubstantivecriteriainprioritizing mortgagors.First,prioritywilllikelybegivenatfirsttothosehomeownerswhoappear,onthe basisofexistingloanlevelinformationincludingcredithistoryandthemortgagedproperty itself,toqualifyforrefinancingintonewFHAfirstmortgageloansof95%LTV.Thatisagainan erronthesideofcautionprinciple,basedonthehighsuccessratesofFHAconforming mortgageloansoverthepast80years. Second,prioritywillpreliminarilybegiventofirstmortgageloansheldinprivatelabel securitizationtrusts(PLSTs),aswellasassociatedsecondmortgageliens.Thisisinorderto minimizethenumberofpartieswithwhommunicipalitiesmustnegotiateinpurchasing qualifyingloansandrepaymentrightstherebypreventingreplicationofthecoordination challengesthatnecessitatelocalactioninthefirstplace. OncethePlanisfullyunderway,municipalitiesorauthoritieswillpresumablyconduct furtheriterationsinwhichnonPLSTheldloanslikewisearepurchasedandrefinancedin cooperationwithobligors.ItappearsthatCaliforniaisthesitusofapproximately565,700 mortgageloans38%ofallunderwatersuchloansheldinPLSTs.110 AparticularmunicipalitysuchasSanBernardinoCountymightreasonablyanticipate thatsome6,000homeowners,withmortgageloansheldbysome4,000PLSTsmanagedby
108 109 110

Seeagaininfra,AppendixA,forfullertechnicalexplication,explanation,andjustificationofthesecriteria. Citeforthcoming. Basisforthcoming.

33

merelytwelvetrustees,willcompletetheoptinprocessduringthefirstphaseofitsuseofthe Planafteracquiringthequalifyingmortgageloans.Theseloansmightjustasreasonablybe expectedtopossessanaveragefairmarketvalue,asthistermofartisdefinedunderCalifornia law,ofsomewhereintheneighborhoodof$150,000.111TheCounty,inturn,mightdetermine toerronthesideofcautionbyplacing,say,$1billionintotheaforementionedstatemanaged escrowaccountonbehalfofthePLSTsfromwhichitwillpurchasetheloans. TheCountyorAuthorityinmostcasesalsowilltreattogetherallloansinconnection withwhichanyspecifictrusteeactsonbehalfofsomePLSTpresentlyholdingtheloans.That againenablesacountylikeSanBernardinoeffectivelytoeliminatethecoordinationchallenges thathaveblockedloanrestructuringthusfaramongitsfirst6,000qualifyingresidentsand manythousandsifnotmillionsofdispersedPLSTbondholders.Foritwillnowbe negotiatingwithameretwelvetrustees.Thenew,refinancedloansthatreplacetheold, underwaterloanswillthenultimatelybegroupedtogetheragain,withthepartnering institutionsthatfinancethemunicipalitiespurchasesholdingtheresultantbonds. Ineffect,eachmunicipalityorauthoritythatadoptsandactsonthePlanwillbetaking possessionofmortgageloanstoresolveandrefinancetheminshort,tonegotiateEV maximizingprincipalwritedownsthatlendersandborrowersalikewishtoseebutcannot separatelynegotiateinlightoftheimpedimentscataloguedinSectionII.Insodoingitwillalso beacceptingdiscountedrepaymentintheformofproceedsfromnewmortgageloans.These latterinturnareoriginatedspecificallyforthepurposeofconveyancetoparticipatingprivate investors,asrepaymentinkindofthemoneysthattheinvestorslendthemunicipalityupfront tofinancethecondemnationaward.112 InoperatingpursuanttothePlan,eachmunicipalitywillhavepreservedneighborhood integrity,propertyvalues,andtherevenuebasefromwhichitfundsservices.Itwillhavekept itsownresidentsintheirownhomesstillowningandpayingonthemratherthanfallinginto defaultandforeclosurethatharmslendersnearlyasmuchasitdoesborrowers.Itwillalso haveenabledresidentstogetoutfromunderthedebtoverhangthatforsixyearsandcounting hasincreasinglytoimperilednotonlythem,buttheirlenders,theirneighbors,andthestate, local,andnationaleconomiestoboot.

111 Seeinfra,note142,andassociatedtextformoreonthetechnicalmeaningoffairmarketvalueunder Californialaw.ThedollarfigureisfromDQNEWS. Asnotedsupra,note98,theremightbeasmallcohortofmortgageloansthat,foronereasonorother, 112 ultimatelyprovenottoberefinancable.Suchloansofthisdescriptionasmightemergewillbesoldby municipalitiesinthewholeloanmarketforcash,whichcashwillthenalsobereturnedtoinvestors.

34

Inshort,theMunicipalPlanisanefficientandSolomonicsolutionthattreatseveryone fairlyandprotectscountlessthirdpartiesagainsttheimmenselydestructivespillover consequencesofmassforeclosureaswell.Therehasneverbeenamorefittinguseofthe statestraditionaleminentdomainauthority. IV.ThePlansConstitutionalBasisandLegalProceduralDetails TheMunicipalPlanmakesessentialuseofthestatesandtheirinstrumentalities traditionaleminentdomainauthority.Itwillaccordinglybehelpfulnowtolayoutthebroad contoursofthisauthorityanditsapplicabilitytothepurposespursuanttowhichthePlan employsit.Thatwaywelayoutthestructureofthis,legallayerofthePlanjustasSectionIII haslaidoutthestructureofitsfinanciallayer.113 ThetwolayerstogetherconstitutetheentiretyofthePlanmuchasacontourmap capturesasaliententiretyofageographicalregion.Inanimportantsense,however,thelegal layerismorefundamental.Forthestatescanactonlyinkeepingwiththeirlegalauthority, PlanornoPlan.On,then,tothisauthorityonthebasisofwhichthePlanenvisagesstatesand municipalitiesacting. Theeminentdomainauthorityisoflongstandinginboththecivilandcommonlaw traditions.EvenasearlyanarticulationoftheauthorityasthatfoundinGrotiussDeJureBelli etPacisreadsstrikinglylikecontemporaryarticulations.114Theguidingideabehindeminent domainmightbebetterconveyedincontemporarytermsbysubstitutingthenowmorefamiliar preeminentanddominionforthemorearchaiceminentanddomain.

113 BecausethisMemorandumismeanttobeintelligibletononlawyers,thereismoreinthewayof backgroundexplanation,andsomewhatlessinthewayofluxuriantcitationtoauthority,herethantherewouldin anappellatebriefofthesortthattheauthorisaccustomedtopenning.Asamplesuchbrief,formattedandciting assuchbriefsthemselvesdo,appearsasAppendixBthelegalcounterparttothatsamplefinancialtermsheet thatappearsasAppendixA.Allconstitutional,statutory,andcaselegalauthorityrelieduponinthisSection, however,stilliscitedinfull.Theresimplywillnotbecitationsforliterallyeverysentenceasisgenerallythecasein briefsfiledincourt. HereisGrotius:Thepropertyofsubjectsisundertheeminentdomainofthestate,sothatthestateor 114 hewhoactsforitmayuseandevenalienateanddestroysuchproperty,notonlyinthecaseofextremenecessity, ...butforendsofpublicutility,towhichends...privateendsshouldgiveway.Butitistobeaddedthatwhen thisisdonethestateisboundtomakegoodthelosstothosewholosetheirproperty."SeeHUIGDEGROOT (Grotius),DEJUREBELLIETPACIS(TheLawofWarandPeace)(1625),availableonlineat http://www.lonang.com/exlibris/grotius/index.html.(FormoreonGrotius,seeROBERTHOCKETT,THELITTLEBOOKOF BIGIDEAS:LAW(2009).)Contemporaryarticulationsoftheeminentdomainauthoritytofollow.

35

Thegistofpreeminentdominionisthatanysovereignauthoritythenation,astate, orsomeotherfundamentalunitofgovernmentsolongasitactsonbehalfandinthenameof thepeople,holdsadominionoverpropertywithinitsjurisdictionthatisimplicitlypriortothat ofanyparticularindividual.Thisitmaysparinglyexerciseasagainstanysubordinateprivate dominionoverthepropertyinquestion,whenandonlywhennecessaryforthegoodofall, provideditpayjustcompensationwhensodoing. Becausethisauthorityisasplenaryasthesovereignsjurisdictionitselfandaccordingly operates,liketherelevantunitofgovernmentitself,inthenameofthesovereignpublicor peopleasawhole,itisapplicabletoallformsofpropertyrealorpersonal,tangibleor intangible,integralorfragmentary.Aunitofgovernmentthatcanexercisepersonaljurisdiction andtherebyhaulyouintocourt,tryyou,condemnyou,imprisonorevenexecuteyou, unsurprisingly,canexerciseinremjurisdictionoverandcondemnyourinanimatepossessions aswell.Thequestionsnotwhether,buthowwithinwhatlimitations. Theonlyinherentlimitationsontheeminentdomainauthorityarealreadyimplicitin thecharacterizationsjustgiven.Asitisultimatelythepublicsorpeoplesauthorityinthe U.S.,theauthorityofthatWe,thepeople,whospeakinthePreambletotheConstitutionit canonlybeexercisedforapurposeofthepeople:apublicpurpose.And,presumablybecause aguidingprincipleofthatsocialcontractarianlegalandpoliticalidealthathasbeenpartofthe AmericanethossinceatleastthetimeofthatfavoriteoftheAmericanFounders,JohnLocke, hasbeenthatcitizensshouldnotbemadeworseoffforbeingmembersofapolitythanthey wouldhavebeeninastateofnature,thepublicholdsitselfboundalsotocompensateanyof itsmembersagainstwhoseprivatelyheldpropertyitexercisesitseminentdomainauthority. Thesearetheappositefirstprinciples,whichantedatetheAmericanfoundingand findtheirwayintoAmericanlawviatheBritishcommonlawthatweadopted,thenadapted, fromthecolonialeraondowntothepresent.Anadditionalwrinkleisintroducedinthe Americancase,however,bythefederalsystemofgovernmentthatwealsoembracedwithour Constitution.Pursuanttothedualsovereigntyexercisedbystateandfederalgovernments alikeunderoursystem,bothsitesofsovereigntyholdpowersofeminentdomain.Allthat differsbetweenthem,inessence,istheidentityoftherelevantpublicor,inthetermsof SectionsIthroughIIIabove,therelevantcollectivityonwhosebehalfeachgovernmentacts ascollectiveagent. Toremainwithourearlier,notquiterandomlyselectedexample,then,Californiasstate governmentexercisesitseminentdomainauthorityinthenameofandonbehalfof CaliforniansasresidentsofCalifornia.Thefederalgovernmentexercisesitscounterpart
36

eminentdomainauthorityinthenameofandonbehalfofAmericansascitizensoftheU.S.Of coursethismeansalsothatCaliforniasexerciseofitseminentdomainauthoritywillbe conductedpursuanttoapublicpurposeunderstoodinreferencetothepublicofCalifornia theCaliforniancitizenrywhilethefederalgovernmentssuchexercisesaresymmetrically takenforpurposesofthefullU.S.citizenry. Exercisesoftheeminentdomainoranyotherauthoritybythesedistinctsovereignsmay collaterallybenefitotherpublicsthattheydonotrepresent,ofcourse.U.S.cleanair standardspresumablybenefitmanyoutsideoftheU.S.justassurelyasU.S.carbonemissions mightinduceacidrainelsewhere,forexample.Buttheexerciseofauthoritymustalwaysbe capableofbeingjustifiedbyreferencetothatpublicwhichactuallyauthorizesthegovernment inquestiontoactinitsname. Itisalsothecase,ofcourse,thatcitizensofCaliforniaarelikewisecitizensoftheU.S., meaningthatthereisoverlapamongthepublicswhoareimplicatedbytheU.S.and CalifornianpublicpurposesforwhichU.S.andCalifornianeminentdomainauthoritymightbe exercised.Howthenarethosepurposesdistinguished?Hereitishelpfultorecuronceagainto thenotionofacollectiveactionproblemofthesortthatfiguresprominentlyinSectionsI throughIII.Inessence,ourconstitutionalarrangementissuchastoobserveprinciplesofwhat inotherpartsoftheworldarecalledsubsidiarity. Thebasicsubsidiarianidea,whichtheU.S.honorsunderseveraldistinctterminologies onesuchofcoursebeingfederalismboilsdowntothis:Wheresatisfactionofsome particularinterestrequiresaddressingacollectiveactionchallengethatafflictssomegroupofn personsandnomore,ingeneralthesmallestunitofgovernmentwithjurisdictionoverthosen personsshouldbechargedwithsatisfyingthatinterest. Theinterestofnationaldefense,forexample,andthecollectiveactionredolentfree riderproblemthatimperilsit,isinherentlynationalinscopeinthesensethatnationalforces areneededandallnationalcitizensmustbetaxedtofinancethem,evenwhenthereareor havebeenstateNationalGuardunitsormilitias.Theinterestofpolicinganeighborhood,by contrast,andthefreeriderproblemthatimperilsit,isstraightforwardlylocalandcanbe handledandtaxfinancedaccordingly.115
115 Unlessofcoursethereisanationalinterestinroughequalityofservicequalitynationwide,whichasan inherentlynationalinterestwouldinsomecircumstancesbringfederalsubsidiestounderservedlocalities, financedviafederalrevenues.Counterpartremarksholdforeducation,waterquality,etc.,manyofwhich implicateeithertheEqualProtectionClauseofthe14thAmendmenttotheU.S.Constitutionorpoliticalandhence legislativevaluesthatfindpartialexpressiontherein.Ofcoursewhereschoolingisconcerned,theClauseitselfhas beenheldtorequireverylittle,alas.SeeSanAntonioInd.Sch.Dist.v.Rodriguez,411U.S.1(1973).

37

 Inbetweenthesetwohighestandlowestlevelsofgovernment,national subdivisionslikestates,orcoalitionsthereof,willbebestsuitedtohandlingcertainmatters thataffectmultiplecitiesortownshipswithintheirjurisdictionswhilenotaffectinganyoutside ofthemmattersconcerningthemanagementofcertainsharedriversorlakes,forexample. AnimportantfeatureoftheAmericanrenditionofsubsidiarityforpresentpurposesis itsvestingjurisdictionovermattersofrealproperty,trustandestates,contract,and commerciallawthestuffofhousing,homeownership,realestateandmortgagefinance almostexclusivelywiththestates.116Legaldoctrinallyspeaking,thatvestingtakestheformof statesreservation,viatheConstitutions10thAmendment,ofwhatisknownasaresidual policepowerovermattersnotexpresslyorimpliedlyplacedunderimmediateoroptional federaljurisdictionbyotherprovisionsoftheConstitution. Policehere,importantly,istobeunderstoodinthesenseofpolicyratherthan constable,thoughthetermdefinitelyembracesthenotionofstatesrolesasprotectorsof theircitizens,andinthatsenseasregulatorsofactivitiesthatcanharmorposesignificantrisks tothem.Thisis,again,aresidualplenaryauthority,understoodasthatfundamentalbaseline fromwhichthefederalconstitutionssocalledenumeratedpowersconstituteonlydiscrete, limited,conditionalexceptions. Statesortheirinstrumentalitiesrolesascollectiveagentsinthiscontext,then,as suggestedinintroducingthisSectionabove,canbeviewedasoccupyingacontractand propertylegallayeroverwhichtheirrolesascollectiveagentsassuggestedinSectionIIIserve asamortgagefinancialoverlay.Fundamentally,stategovernmentsexercisetheirpolice powers,ofwhichtheeminentdomainpowerisbutone,bothinthenameofandonbehalfof thecollectivityoftheircitizensmostofwhomarehomeownersandneighborhooddwellers, andmanyofwhomareborrowersandlenders. Collaterally,though,insomecasesofsodoingtheywillalsobeassistingtheircitizensin theresolutionofcollectiveactionproblemsthatthesecitizensfaceinconjunctionwithoutof

116 Henceallstateshavetheirownpropertycodes,andnearlyallhavetheirownversionsoftheUniform CommercialCode(UCC),Article2ofwhichcoverscommercialcontracts,Article9ofwhichcoverssecured transactionsincludingmortgagesecuredsuchtransactions,andArticle3ofwhichcoversnegotiableinstruments includingpromissorynotesofthesortmortgagorsconveytomortgagees.Significantly,thereisnonational propertycode,noristhereanynationalcommercialcode,theuniformityoftheUCCsignifyinganaspirationof thedraftersandPermanentEditorialBoard(PEB)thatstatesvoluntarilyharmonizepreciselybecausethereisno federallyimposeduniformity.SeegenerallyHockett,SixYearsOnandStillCounting,supranote3.

38

stateotherstowhomtheyrelateincontract,soaseffectivelytobenefitall.Thisis,ofcourse, whatwehavefoundinconnectionwiththeMunicipalPlanelaboratedaboveinSectionIII. Inthejustmentionedinterstatecontractingconnectionitofcoursebearsnotingthatit isacommonplaceoftheAmericanconstitutionalorderthatjurisdictionovermatters concerninginherentlyorundeniablyinterstatecommercecanbeexercisedbythefederal legislature.Itisnotquiteascommonplace,butatleastisnotorioustomanyalawstudentpast thefirstyear,thatsomesuchmattersarethoughttobesoessentiallyinterstateincharacteras tocountasimplicitlyrequiredtobekeptuniformacrossstatesevenwhenCongresshasnot affirmativelyactedsotorequire.117 Butwhatismoststrikingagainstthisbackdropishowmuchourconstitutionalorder neverthelessreservestothestatesand,inparticular,howmattersofcontract,commercial, andespeciallypropertylawcontinuetobealmostentirelymattersofstatelawunderthat order.Wereallydoremain,inasignificantsense,asortofcompactofstates. Onemorewrinkleimportanttonoteinconnectionwithbothourfederatedformof subsidiarityandtheplaceoftheeminentdomainauthorityinAmericanlawcomeswiththerole ofmunicipalitiesinoursystem.BecausethefederalConstitutionwashistoricallyacompact enteredintobywhatwereviewedasthirteenantecedentlysovereignstates,statesare effectivelyviewedasbeingamongtheoriginaldelegatorsofauthorityinoursystem. ThefederalgovernmentsbeingacreatureofthePeopleindependentlyofthestates, assuggestedbythePreambletotheConstitution,findsexpression,legislativelyspeaking,inthe HouseofRepresentatives,whereinstatesarerepresentedinproportiontotheirpopulations. Butthefederalgovernmentsbeingalsoandsimultaneouslyacreatureofthestatesalsofinds expressioninournationallegislatureinthiscaseviatheSenate,whereineachstateis represented,asastate,bythesamenumberofSenators. Ifstatessharetheirdelegationofauthoritywiththepeopleofthenationasawhole wherefederalgovernanceisconcerned,however,theyarethesoledelegatorsofauthorityto theirownmunicipalities.Theyarenotviewedunderourlawascompactsorfederationsof
117 Thisisthedomainofthesocalleddormant,orimplicitCommerceClause,essentiallyinterpretedasa prohibitiononprotectionismonthepartofstatesoffirmslocatedwithinthemattheexpenseofcompetingfirms locatedinotherstatesasortofGATTorWTOofthestates.NotoriousexamplesincludeSouthCarolinasonce prohibitingdeliverytrucksofaparticularsizefromusingitshighways,widelyrecognizedasameansofprotecting localproducersagainstimportsfromneighboringstatecompetitors.Peoplewhofretoverjudicialactivismare amongthosewhomostloathethenotionofadormantCommerceClause.Ifitsasleep,letitlieuntilCongress expresslyawakensit,theyineffectcomplain.

39

theircitiesandtowns,inotherwords,asthefederalgovernmentisviewedasafederationof unitedstates.Insteadthetermthatthelawusesinthiscontextiscreatures. Municipalitiesarecreaturesofstatelaw,justasaretrusts,corporations,andotherlegal entities.Indeed,inmoststates,municipalitiesareinfactlegallyknownasmunicipal corporations,fromwhencederivesthenotionofincorporatingatown. Thesignificanceofthisrelationbetweenstateandmunicipalityforpresentpurposesis twofold.First,evenwhenemployedbymunicipalities,asittypicallyispursuanttostate delegationunderhomeruleorcognatestatutes,theeminentdomainauthorityisstate authority.Inthatsenseitislocatedattheverycoreofourfederalsystemofgovernmenta speciesofauthoritythatbelongstothestatesquiteasfully,ifnotindeedmoreso,asitdoesto thefederalgovernment. Second,indelegatingtheeminentdomainpowertotheirmunicipalitiesasstates generallydo,theyaredelegatingittoentitiesthatareinacertainsenseonalevelwithother organizedentitiescreatedunderstatelawevenprivatesuchentitiessuchastrusts.Henceit isunsurprisingthatmunicipalitiesoftenworkinpartnershipwithotherentitiesinpursuing publicpurposesthroughuseoftheeminentdomainpowerastheMunicipalPlanitself envisages.Thishasbeenthewayofeminentdomainsincetheearliestdaysofourrepublic. ThattakesusontotheMunicipalPlaninparticularanditsstatusasafamiliarand altogetherorthodoxexerciseoftheeminentdomainpower.Forexpositorypurposesnoted aboveinnote54andthetextthataccompaniesit,weshallonceagainassumeuseofthePlan inaparticularstate:California.Forthesamepurposesweshallalsoassumethesamecountyas before:SanBernardino. Takingsomeotherstateormunicipalityforourillustrativeexamplemightaffectthe analysisweshallnowundertakeatthemargin,butonlyatthemargin.Thatisbecauseallof thestateseminentdomainregimesarequitesimilar.Allonewouldhavetodotoapplythe forthcominganalysistoadifferentstateandmunicipalitywouldbetocitedistinctstate constitutional,statutory,andmunicipalprovisionsaswellasjudicialconstructionsthereof,and thenaccommodatesuchminorterminologicalwrinklesasthesevariationswouldintroduce. BacktoCaliforniaandSanBernardino,then,forpurposesofthepresenthypothetical legalanalysis.TheMunicipalPlansuseofeminentdomainauthoritywillbesubjectbothtothe federalandtothestateconstitutionsfirstthelatter,thentheformerasafinalcheckonthe latter.TheCaliforniaprovisiononpointisarticleI,Section19ofthestatesConstitution. Subsection(a)thereofreads
40


Privatepropertymaybetakenordamagedforapublic useandonlywhenjustcompensation,ascertainedbyajuryunless waived,hasfirstbeenpaidto,orintocourtfor,theowner.The Legislaturemayprovideforpossessionbythecondemnorfollowing commencementofeminentdomainproceedingsupondepositincourtand promptreleasetotheownerofmoneydeterminedbythecourttobe theprobableamountofjustcompensation.118

Thepublicuseandjustcompensationlimitationsareofcoursecommonsomuchsothat theintroductorydiscussionabove,itmighthavebeennoted,employedthesameterminology withoutreferencetoanyparticularstateorfederalconstitutionalprovision.Thereferenced requirementtoplacepotentialcondemnationawardmoneystheprospectivejust compensationinescrowislikewisecommon,andisofcourseonereasonforprovisiontodo sointheMunicipalPlanaslaidoutaboveinSectionIII. Theapplicablefederalconstitutionalprovisiononpoint,thesocalledTakingsClause oftheFifthAmendment,isnomorerestrictivethantheCaliforniaprovision.119Indeedif anything,itislessso.FortheU.S.SupremeCourtnotoriouslyhasinterpretedtheprovisionto allowgovernmentcondemnationofprivateresidencesforpurposesofconveyingthemto privatepartiesinthenameofeconomicdevelopment.120California,bycontrast,ismore arguablysolicitousofhomeownersinterestinremainingintheirhomes.Henceitpurportsto forbidKelostyletakinginsubsection(b)oftheaforecitedSection19.121Ingeneral,however, theU.S.andCaliforniaprovisionsaresufficientlyinagreementastounderwriteCalifornia courtsregularlycitingtobothstateandfederaldecisionsincasesinvolvingtheexerciseof eminentdomaininthestate.122 Next,asnotedabove,eminentdomainauthorityisexercisableoverallformsof propertyrealorpersonal,simpleorfragmentary,tangibleorintangible.That,again,isthe
118 Cal.Const.art.I,19(a). U.S.Const.,amend.V(...norshallprivatepropertybetakenforpublicuse,withoutjust 119 compensation.).Whatisperhapsmostnoteworthyaboutthisclauseisthefactthatitpresupposesthatprivate propertyregularlyis,andaccordinglymay,betakenforpublicuse,withtheclausepurportingtorestrictthe commonpracticeonlybyreiteratingthatjustcompensationistobepaid. Kelov.CityofNewLondon,545U.S.469(2005). 120 121 Cal.Const.art.I,19(b)(TheStateandlocalgovernmentsareprohibitedfromacquiringbyeminent domainanowneroccupiedresidenceforthepurposeofconveyingittoaprivateperson.).Itshouldperhapsbe noted,ifonlyinpassing,thatsubsections(c)and(d)goontolimitsubsection(b)itselfsomewhat,intheformof familiarexceptionsforpublichealthorpublicworksprojects. SeeCountyofVenturav.ChannelIslandsMarina,Inc.,159Cal.App.4th615(2008).GiventhepostKelo 122 dateofthisciteddecision,ontheonehand,andtheexceptionstosubsection(b)ofthesection19oftheCalifornia ConstitutionsarticleIcitedinthepreviousnote,theremightbesomereasontoquestionwhetherCalifornia takingslawisindeedmorerestrictivethanfederaltakingslawunderKelo,asIsuggestedabove.

41

caseeverywherethateminentdomainauthorityisrecognized,beitincivilorcommonlaw jurisdictions. Underthefederalrenditionofthisauthority,foritspart,theU.S.SupremeCourtand theCourtsofAppealshaveregularlyheldthattheauthorityextends,forexample,tocontract rights,123insurancepolicies,124sharesofstock,125businessesasgoingconcerns,126hunting rights,127rightsofway,128andallmannerofadditionalintangible.U.S.statesfollowthesame longstandingcommonlawtraditionasdoesfederallawinthisconnection.129Californias SupremeCourt,forexample,longhasexplicitlyrecognizedthat[thestates]eminentdomain lawauthorizesthetakingofintangibleproperty.130 Inviewofthelawsdrawingnodistinctionsbetweenkindsofpropertythatcanbe condemnedineminentdomainproceedings,itshouldcomeasnosurprisethatliensin particular,asmerelyoneformofcontractualobligationamongmany,allofwhichcanbe condemned,arethemselvesregularlycondemned.131Amongthoseliensare,ofcourse, mortgageloansandliens,astheU.S.SupremeCourtandotherstatecourtshaverecognized.132 Hence,again,theexplicitrecognitionbytheCaliforniaSupremeCourt,too,that[n]o constitutionalrestriction,federalorstate,purportstolimitthenatureofthepropertythatmay betakenbyeminentdomain.133 Theonlycomplicationatallthatisintroducedintoeminentdomainanalysisby intangiblepropertyhastodowiththeeffectthatintangibilityhasonstatecourtsjurisdiction, sinceintangiblescannotbeliterally,spatiallylocated.Thelawhaslongbeenawareofthe

123 See,e.g.,UnitedStatesTrustCompanyofNewYorkv.NewJersey,431U.S.1,19(1977). 124 See,e.g.,Lynchv.UnitedStates,292U.S.571,57779(1934). 125 See,e.g.,Offieldv.NewYork,NewHaven&HartfordR.R.Co.,203U.S.372(1906). 126 See,e.g.,KimballLaundryCo.v.UnitedStates,338U.S.1(1949). 127 See,e.g.,SwanLakeHuntingClubv.UnitedStates,381F.2d238(5thCir.1967). 128 See,e.g.,CityofCincinnativ.Louisville&NashvilleRailroadCo.,223U.S.390(1912). See,e.g.,NewYork,N.H.&H.R.Co.v.Offield,59A.510(Conn.1904)(Connecticut,condemningstock); 129 Spencerv.SeaboardAirLineRy.Co.,49S.E.96(N.C.1904)(NorthCarolina,condemningstock). 130 CityofOaklandv.OaklandRaiders,32Cal.3d60,68(2008)(condemningasportsfranchise). See,e.g.,Phillipsv.WashingtonLegalFoundation,524U.S.156(1998)(accruedinterestonaccount 131 funds);Armstrongv.UnitedStates,364U.S.40(1960)(materialmanslien);andtheiconicLegalTenderCases,79 U.S.(12Wall.)457(1870). See,e.g.,LouisvilleJointStockLandBankv.Radford,295U.S.555,602(Ifthepublicinterestrequires... 132 thetakingofpropertyofindividualmortgageesinordertorelievethenecessitiesofindividualmortgagors,resort mustbehadtoproceedingsbyeminentdomain.);W.Fertilizer&CordageCo.v.CityofAlliance,504N.W.2d808, 816(Neb.1993)(NebraskaSupremeCourtholdingthatamortgageeslienonrealestateisaninterestthatmay besubjectedtoatakingforapublicpurposeand,therefore,maybethesubjectofaneminentdomain proceeding.). OaklandRaiders,supranote130,32Cal.3dat67. 133

42

factthatintangiblesarenottangibleandaccordinglynotspatiallylocated,however,andits doctrineshaverespondedaccordingly. Becausethedoctrinesofdueprocess,inpersonam,inrem,territorialandsubject matterjurisdictionthroughwhichitdoessoareparticularlycomplexandtechnicalbothin themselvesandintheirinteractions,though,itwillbewelltodeferfullertechnicaltreatmentto thetechnicallegalappendixthatisAppendixB.134Forpresentpurposesitwillsufficeto observethatingeneral,courtsfindthesitusofadebtinstrumenttobeinthedomiciliarystate ofthedebtor,135andthesitusofrealestatemortgagedebtinparticulartobethestateinwhich themortgagedpropertyisitselflocated.136 Itwillbenotedthatwherethemortgagedebtorisdomiciledinthemortgagedhome itself,asisinfactrequiredtoqualifyforloanmodificationundertheMunicipalPlanas elaboratedinSectionIII,bothoftheaforementionedgroundsofstatejurisdictionconverge. Thisentailsthatthestateenjoysbothinremjurisdictionoverthedebtandtheproperty securingit,anddueprocessconsistentinpersonamjurisdictionoverthecreditor/mortgagee, bothoftheseultimatelyinvirtueoftheterritorialjurisdictionithasoverthespaceinwhichthe mortgageeandherhomearerespectivelydomiciledandlocated.Subjectmatterjurisdiction, foritspart,ishereamatteroftraditionalstateauthoritydelegatedtomunicipalities,moreon whichpresently. Federalandstateconstitutionalauthoritytoexercisetheeminentdomainpowerover intangibleslikemortgagenotesascontemplatedbytheMunicipalPlan,then,issecure.The sameholdsofpowertotransferacquiredsuchpropertytangibleaswellasintangibleto privateentities.Inthecaseoffederallaw,ofcourse,thelatestandmostoftcitedwordonthe matteristheU.S.SupremeCourts2005Kelodecisionmentionedabove.California,asalso notedabove,issufficientlysolicitousoftheinterestofhomeownersinstayingintheirhomesas tolimitcondemnationofresidencesforpurposesoftransfertoprivateentities.Thatisof

134 TheauthortaughtCivilProcedureIandCivilProcedureIIinthelegalacademyduringhisfinalyearasa doctoralstudent.Thefirstofthosecoursesisinitsentiretydevotedtothesubjectofjurisdiction,whichinvolves notonlycodesofprocedure,butsuchconstitutionalinterestsasdueprocess.Hetruststhatthereaderwould ratherthisfullsemestercoursebesummarizedinanappendixthanovermultiplepageswithinthepresenttext. See,e.g.,theoldchestnuts,belovedofallprofessorsandstudentsofCivilProcedure,Harrisv.Balk,198 135 U.S.215(1905);andChicago,RockIsl.&Pac.Ry.Co.v.Sturm,174U.S.710(1899).InCaliforniainparticular,see Waitev.Waite,6Cal.3d461(1972). Herethejurisdictionismediatedbytheunseverablelinkbetweenmortgageandnote.SeeCarpenterv. 136 Longan,83U.S.271,274(Thenoteandthemortgageareinseparable.);andHydev.Mangan,88Cal.319,327 (1891)(Thedebtandsecurityareinseparable;themortgagealoneisnotasubjectoftransfer.).Formoreonthis matter,anditsconsequentweddingofinherentlystatecentricpropertyandcommerciallaw,seeHockett,Six YearsOnandStillCounting,supranote3.

43

coursegoodnewsfortheconstitutionalityoftheMunicipalPlan,aprincipalpurposeofwhichis preciselytopreventforeclosures,evictions,andexpropriationofhomeowners. AlsogoodnewsisthefactthatCaliforniaisasopenasistheU.S.SupremeCourtto transferofcondemnedintangibles,aslikewisecontemplatedintheMunicipalPlan.Theonly restrictioninthiscaseistheearlierdiscussedpublicpurposerequirementthatisattheheartof theeminentdomainpower,totheprecisecontoursofwhichunderU.S.andCalifornialawwe shallturninduecourse.Californiasauthorizationofthetransferofcondemnedintangiblesis foundinitsCodeofCivilProcedure,137andiswellrecognizedbythestatesSupremeCourt.138 Thenextthingtonoteisthat,assuggestedbythecitationjustmadetoCaliforniasCode ofCivilProcedure,statutorylawpromulgatedbystatelegislaturesaffordsfurtherguidanceto useoftheeminentdomainauthority.TokeepwithoursamplestateCaliforniathen,the applicablelawis,asjusteffectivelynoted,foundinthestatesCodeofCivilProcedure,Sections 1230.0101273.050,knownasthestatesEminentDomainLaw. ThisLaw,foritspart,firstrequiresthatexpressstatutoryauthorityauthorizeany particulargovernmentinstrumentalitysuseoftheeminentdomainpower.139Asforthe questionofwhatsuchinstrumentalitiesmightdoso,Californiaconformstothegeneral observationsmadeabovethat(1)municipalitiesandjointpowersauthoritiesthemselves exercisethesepowersonlyinsofarasstatesdelegatethemtothem,while(2)moststatesdoin factthusdelegatethem.HenceinCalifornia,municipalitiesandjointpowersauthorities(1) exerciseeminentdomainauthorityonlywhenexpresslyauthorizedbylaw,140while(2)they areinfactexpresslyauthorizedbylawtoexercisethisauthority.141 Asinotherstates,statutoryguidancealsofurthercontoursthedeterminationofwhat countsasjustcompensationinCaliforniathatwhichmust,againunderboththeTakings Clauseofthe5thAmendmenttotheU.S.ConstitutionandunderSection19ofArticleIofthe CaliforniaConstitution,bepaidthosewhosepropertyiscondemnedundertheeminentdomain
137 SeeCal.Civ.Proc.1240.120(b)(propertycondemnablewiththeintenttosell,lease,exchange,or otherwisedisposeof[thesame]...). OaklandRaiders,supranote130,32Cal.3dat68182(Solongasadequatecontrolsareimposed[to 138 ensuretransfertoprivateentityitselffurtherspublicpurpose],thereisnoreasonwhythepublicpurposewhich justifiesatakingmaynotbesoservedandprotected.). SeeSection1240.020(Thepowerofeminentdomainmaybeexercisedtoacquirepropertyfora 139 particularuseonlybyapersonauthorizedbystatutetoexercisethepowerofeminentdomaintoacquiresuch propertyforthatuse.). OaklandRaiders,supranote124,32Cal.3dat64.AlsoCiv.Proc.1240.020(b)(powerexercisableonly 140 byapersonauthorizedbystatutetoexercise[it].). SeeCal.Govt.Code37350.5. 141

44

authority.CaliforniasEminentDomainLawprovidesthatguidanceinitsSections1263.310and 1263.320(a). AsmentionedaboveinSectionIII,thefirststipulatesthatfairmarketvaluebepaidfor thepropertytaken.Alsoasmentionedabove,thesecondunpacksfairmarketvalue essentiallyasthehighestpriceapttobereachedbywillingcounterpartiesbargainingunder conditionsofunforcedsale.142TherewillbemoretosayonthisinAppendixA,whichtreatsof valuationmattersingreatertechnicaldetail. Thefinallimitationupontheeminentdomainauthorityaboutwhichabitmoreshould besaidisthepublicpurposerequirementmentionedabovewithourfirst,preliminary characterizationoftheauthority.Whiletherequirementhasalwaysbeenimplicitinthe doctrineofeminentdomainitselfsincewellbeforeanyoneknewtherewouldonedaybea UnitedStatesofAmericatherequirementfindsmorespecificexpression,again,inspecific provisionsoffederalandstatelaw. TheapplicablefederallawissimplytheSupremeCourtselaborationofthepublicuse requirementimplicitintheaforementionedTakingsClause.Theapplicablestatelawcomprises (1)theaforementionedSection19ofArticleIofthestatesConstitution,(2)Californiastatutory provisionstobeconsideredpresently,and(3)statejudicialconstructionsof(1)and(2). Thebasicgroundingofstateandmunicipalexercisesofeminentdomainauthority amountstoakindofcombinedsubjectmatter,personal,andterritorialjurisdiction.Itisthe policepowermentionedaboveinpreliminarilycharacterizingthedoctrineofeminentdomain generally.TheU.S.Constitutions10thAmendmentspecificallyreservesthispowertothe states,andmostofthestatesinturndelegateportionsofthispowertotheirmunicipalities alongmoreorlesssubsidiaristlinesaselaboratedabove.Californiadoesthisthroughits constitutionsarticleXI,Section7,whichprovidesthat[a]countyorcitymaymakeand enforcewithinits[territorial]limitsalllocal,police,sanitary,andotherordinancesand regulationsnotinconflictwithgenerallaws.
142 Thestatutorylanguagereadsthus:Fairmarketvalueisthehighestpriceonthedateofvaluationthat wouldbeagreedtobyaseller,beingwillingtosellbutundernoparticularorurgentnecessityforsodoing,nor obligedtosell,andabuyer,beingready,willing,andabletobuybutundernoparticularnecessityforsodoing, eachdealingwiththeotherwithfullknowledgeofalltheusesandpurposesforwhichthepropertyisreasonably adaptableandavailable.Furtherguidanceisprovidedintheformofastipulationthatexistingcomparable marketscanbeusedinascertainingthementionedcounterfactualwould.Absentsomesuchcomparable market,theEminentDomainLawpermitsdeterminationoffairmarketvalueasdeterminedbyanymethodof valuationthatisjustandequitable.SeeCiv.Proc.1263.320(b).ThediscussionoverSectionsIthroughIII above,aswellasthatoverSectionIVbelow,wouldseemtohavesomebearingonwhatisjustandequitablehere.

45

Asthecatchallotherordinancessuggests,thepolicepowerisverybroadindeeda plenaryauthoritytogovern,subjectonlytothelimitationthat[themunicipalitiesexercising thepower]exercise[it]withintheirterritoriallimitsandsubordinatetostatelaw.143Henceit permitsmunicipalitiesauthoritytoenactlawstopromotepublichealth,safety,moralsand generalwelfare.144 Presumablybecause(1)statesandmunicipalitiesemployeminentdomainauthorityin exercisingtheirpolicepowers,while(2)thesepowersarethemselvesverybroadperthe federalConstitutions10thAmendment,theU.S.SupremeCourtsconstructionoftheeminent domainpublicpurposerequirementisverydeferentialtostateandmunicipallegislative judgmentsofpublicpurpose.ThebestknownexemplarisagaintheCourtswidelydiscussed Kelodecisionof2005,inwhichthecityofNewLondon,Connecticutscondemnationofhomes withrelativelylowmarketvalueforpurposesofmakinglandavailabletoprivatedevelopers wasupheld.Theprofferedpublicpurposeinthiscasewaseconomicdevelopment,whichthe citythoughtalikelycollateralbenefitofthedevelopersproposedfacility.TheCourtforitspart recognizedtheinterestineconomicdevelopmentasalegitimatepublicuseforpurposesof theeminentdomainauthority. TwootherpublicpurposescommonlyrecognizedbothbytheSupremeCourtandall othercourtsintheU.S.areparticularlyappositetotheMunicipalPlan.Oneisthelong recognizedpublicinterestinreversingorpreventingblight.Sovenerableisthisparticular purposethattheCityofNewLondonitselfappealedtoitinjustifyingtheactionmentioned above. Morecommonappealstotheblightreversalorpreventioninterestgroundthemselves inactualabandonedordecayinghomes,emptyingneighborhoods,overgrowinglawns, crumblingroadsandotherinfrastructure,andthelike.145Again,notonlyreversal,butalso preventionofdevelopmentssuchasthesebothofwhichtheMunicipalPlanbyitstermsaims toeffectcountsasapublicuseparexcellenceforpurposesofjustifyingexerciseofthe
143 Suterv.CityofLafayette,57Cal.App.4th1109,1118(1997).Notethat,structurallyandfunctionally speaking,themunicipal/staterelationisbeingcharacterizedasanalogoustothestate/federalrelation.Allthat differsistheputativefontoftheauthorityinquestion,theconceitinthestate/federalcasebeingthatthestates confer,alongwiththePeople,authorityuponthehigherlevelfederalgovernment,whileinthe municipal/statecasetheconceitisthereverse,withthestatedelegatingauthoritytothelowerlevelmunicipal governments.AsmentionedearlierinthisSection,however,theconceitisimportant,inthatitimpartstoour federalismatendencytotreatstatesandtheireminentdomainasinacertainsenseasormorefundamental as/thanthefederalgovernmentanditseminentdomainpower.ThismightaccountforthehighdegreeofU.S. SupremeCourtdeferencetostateandlocalexercisesofeminentdomain,asdiscussedpresently. CommunityMemorialHosp.v.CountyofVentura,50Cal.App.4th199,206(1996). 144 145 HerethechestnutcaseisBermanv.Parker,348U.S.26(1954).

46

eminentdomainauthority.146SectionVofthisMemorandum,towhichweproceedpresently, accordinglydocumentsindetailtheblightindeed,blightthatisunprecedentedinmagnitude nowbeingwroughtinmultipleU.S.municipalitiesbytheongoingmortgageforeclosurecrisis. Thesecondpublicpurposeroutinelyupheldaslegitimateinchallengestoeminent domainexerciseistheinterestineliminatingdislocationsinlocalhousingmarketsstemming fromlienholders,servicers,andotherpartiesunwillingnesstoconsenttoshortsales,deedsin lieuofforeclosure,andthelikeaswellascounterpartinabilityofmortgagorstosellatcurrent marketvalueorotherwisetransferpropertyinsatisfactionofmortgagedebt.Liketheblight reversalandpreventioninterest,soisthisonestraightforwardlyapplicabletocasesinwhich theMunicipalPlanwillbepursued. HerethebestknownU.S.SupremeCourtdecisionisthathandeddowninthecaseof HawaiiHousingAuthorityv.Midkiff,147inwhichtheCourtfoundsufficientpublicinterestinthe StateofHawaiiswholesalecondemnationoflandlordsownershipinterestsinrealpropertyin ordertoconveythepropertytotenants.Thepurposeofthecondemnationandtransferwasto reducetheconcentrationofownershipoffeessimpleintheState,whichHawaiihadfound responsibleforskewingtheStatesresidentialfeesimplemarket,inflatinglandprices,and injuringthepublictranquilityandwelfare.148 AgainstthebackdropofMidkiff,itisdifficulttoimagineanyonesfindingtheMunicipal Planspurposesanythingotherthanfullypublic.Thelandlordsinthepresentcase,afterall, themselvesoverwhelminglywishtowritedownprincipalbutarepreventedfromdoingsoby thecollectiveactionchallengescataloguedinSectionII.Theyalso,ofcourse,holdproperty rightsthataremuchmoreattenuatedthanthoseofliterallandlords,owningastheydoonly repaymentrightsandsecurityinterests. Currentsecuritizedmortgageeslikewiseareimmeasurablymoreabsenteethanthe mostabsentofliterallandlords,theformoftheirabsenceinthiscasefragmentedand scatteredallovertheworldastheyare,knowingonlytheirbondinstruments,notthe propertiesthatsecurethembeingpreciselywhatstandsinthewayoftheircomingtogether towritedownprincipalastheywouldiftheycould.Andfinally,asnotedabovetheyarefree andinvitedinanyevent,perthetermsofthePlan,tocontinueasownersbyparticipatinginthe investmentthatfundstheMunicipalPlanitself,thefundersofwhichbecometheultimate resultantcreditors.
146 147 148

Id. 467U.S.229(1984). Midkiff,id.at232.

47

 Somuchforthefederalconstrualofpublicpurpose.Asnotedabove,Californias understandingofpublicusetracksthatofthefederalcourts.149Thereisaccordinglylittleto addinrespectofitscaselawonpoint.Itisworthnoting,however,thattheStatesEminent DomainLaw(whichweshallnowlabelEDL)addsfurtherstatutoryguidance,includingwith respecttoprocedure.First,then,theEDLrepeatstheStatesconstitutionalrequirementof publicuse.150Next,theEDLrequiresthatanymunicipalityorotherStateinstrumentalitysuch asaJPAauthorizedtoemploytheauthorityadopt,beforedoingso,aresolutionofnecessity thatexplainsthepublicuseforwhichpropertyisbeingcondemned.151 Theresolutionforitspartisadoptedinanopenlegislativesession,afterapublichearing onthequestionofnecessityinwhichreasonsforcondemnationareproffered,debated,and assessed.Thesefamiliarlegislativeproceduralrequirementsareofcoursemeanttoensurefull transparency,reasoneddemocraticdeliberation,andfairaccesstoallwhomightwishtotake partinthosecommunityproceedingsinwhichmunicipalitiescontemplateuseoftheireminent domainauthority. Ifandwhenaresolutionofnecessityisthenadopted,themunicipalityobtainsan appraisalofthecondemnablepropertyasdescribedaboveinSectionIII,placestheappraised amountinescrow,andfilesacondemnationactioninCaliforniaSuperiorCourt.152The MunicipalPlancanofcoursebeadaptedtoincorporatewithinitallsuchproceduralstepsas mightbeprescribedbyanyotherparticipatingstatesandmunicipalityseminentdomain statutesandordinances. Butwhowilltheseparticipatingstatesandmunicipalitiesbe,andwhymightthey participate?ThisquestiontakesusstraighttoourfinalSectionwhich,bydescribingmore fullytheimminentconsequencesofcontinueddelayinimplementingsomevariantofthe MunicipalPlanincitiesstillatthecoreofourongoingmortgageforeclosurecrisis,both(1) implicitlyidentifiesmunicipalitiesthatshouldfindthePlanmostattractive,while(2)rendering clearjusthowurgentthepublicpurposethesecitieswillhaveforpursuingthePlanwillbe.
149 See,again,CountyofVenturav.ChannelIslandsMarina,Inc.,159Cal.App.4th615,624(2008)(apartfrom theaforementionedprotectionofresidencesfromKelostyletakingwithaviewtotransferringtootherprivate parties,Californiacourtshaveconstruedthe[counterpartfederalandstatetakingsprovisions]congruently[and] haveanalyzedtakingsclaimsunderdecisionsofboththeCaliforniaandUnitedStatesSupremeCourts.). 150 SeeCiv.Proc.1240.010. SeeCiv.Proc.1245.230.IftheStateLegislaturehasprovidedexplicitlybystatutethatsomeparticular 151 use,purpose,objectorfunctionisoneforwhichthepowerofeminentdomainmaybeexercised,thenthe actionisdeemedtobeadeclarationbytheLegislatureitselfthattheuse,purpose,objectorfunctioninquestion inindeedapublicuse.Seeid.,1240.010. SeeCiv.Proc.1250.110. 152

48

 V.ThePlansManifestPublicPurposeandUrgentNecessity WecompletethisMemorandumbydiscussinginabitmoredetailwhatiscurrently underwayinthosemunicipalitieslocatedatthecenterofourongoingandselfworsening mortgageforeclosurecrisis.Specifically,wenotetheremarkabletollinfamilyand neighborhoodsuffering,ongoingandselfworseningvalueandrevenueloss,andconsequent blightthatrollingforeclosuresarenowactivelybringingintheirwake. Closingonthisnoteservestwocriticalpurposes.Oneistoillustratehowsquarelythe publicpurposerequirement,underwhichcondemnationproceedingsalwaysproceed,ismetby thepurposesthatprompttheMunicipalPlanlaidoutandlegallyanalyzedinSectionsIIIandIV. Indeed,weshallsee,wehaveherewhatamountstoatextbookcaseandthensome. Theotherpurposeweserveisempiricallytosubstantiate,andaffordmoreappreciation ofthetruecostsoccasionedby,thatfinancialandeconomicdynamicelaboratedoverthe courseofSectionsIandII.Ineffect,then,inthisSectionwefurthersupportboththelegaland financialcasesforthePlan,bindalltheforegoingSectionsmorefullytogether,andwhileatit fleshouttheirfullhumanandeconomicsignificanceontheground. Thefirstthingtonoteontheground,then,isthegreatriseinhomevacancyratesin stateshitmosthardbythemortgageforeclosurecrisistodate.U.S.CensusBureaudata indicatethatnonseasonalvacantpropertieshaveincreased51%nationallyfromunder7million in2000toover10millioninearly2010.153TenstatesinparticularincludingCalifornia,in keepingwithourcasestudymethodologysawincreasesof70%ormore.154Othersunbelt andsandstatesArizona,Nevada,andFlorida,forexamplesawtheselargerincreasesas well.Theoverwhelminglygreaterpartofthespikeinallplaces,moreover,hasoccurredsince 2006,whenthebubblepeakedandthenplunged.155

153 SeeGovernmentAccountabilityOffice,VacantProperties:GrowingNumberIncreasesCommunitiesCosts andChallenges,ReporttotheRankingMember,SubcommitteeonRegulatoryAffairs,StimulusOversight,and GovernmentSpending,CommitteeonOversightandGovernmentReform,HouseofRepresentatives,November 2011(hereinafterGAOReport).AlsoFederalReserveBoard,supranote8;Dudley,supranote8;andAlpert, Hockett,&Roubini,TheWayForward,supranote22. GAOReport,id. 154 Id. 155

49

Unsurprisingly,highforeclosureratescloselycorrelatewiththegrowingvacancyrates inquestion,accountinginmanycasesforasmuchasthreefourthsoftheincrease.156Sotoo, then,dohighunderwatermortgagerates,sincethesethemselvescorrelateoverwhelmingly withforeclosuresasnotedaboveinSectionsIandII.157Thisisnotonlybecausepeople ultimatelyleaveforeclosedhomes.Itisalsobecausetheforeclosureprocessitselfisadrawn outaffair,meaningthatforeclosersareunabletoplacepropertiesbackonthemarketquickly evenwheretheremightbedemand.158Asithappens,however,thereislittledemandeither anothersourceofthespikeinvacancyrates.159Allinall,then,thesefactorsslowtherateat whichhomesthatareleftcometobereoccupied,whichofcourseaddsuptospikingvacancy rates. Associatedunemployment,insomecasesresponsibleforforeclosuresthemselveswhile inothercasesattendantoneconomicslumpthatbothreinforcesandisreinforcedbymass foreclosure,isanothersourceofspikingvacancyrates.160Atertiarycauseappearstobe migrationfromhardhitcitiesthatisitselfaresponsetodecliningemploymentopportunities whichthemselvesinteractsymbioticallywithforeclosureratesperthefeedbackeffects discussedabovethroughoutSectionsIandII.161Therearestraightforwardfeedbackeffects betweenthesephenomenaandspikingvacancyrates.162 Growinghomevacancyratesofcourserepresentconsiderableindividualandfamilial trauma.Involuntarilyuprootedfamiliesareatleasttemporarilydeprivedofthemostbasicof humanneedstheneedofshelter,ahomebase,aplacetoconductstablefamilylife.There arecountlessstudiesdocumentingtheincalculablepsychologicalandphysicaltollonchildren, inparticular,wroughtbyforeclosureandeviction.163Thetolltakenonadultsisimmenseas well.Asaqualitativematter,thisallperhapsgoeswithoutsaying.Asaquantitativematter,a 70%spikeinhomevacancyratesisofcoursemuchmorethana70%spikeinratesofthe mentionedtraumas.Forpriortothespike,whatvacanciestherearewillbelesstheresultof foreclosurethantheyareorregulareconomicallyinducedmigration.
156 Seesourcessupra,note153. Seesupra,SectionsIandII,andsourcestherecited. 157 Seenotes156and157. 158 GAOReport,supranote153. 159 160 Seesourcescitedsupra,note153,aswellassupra,SectionsIandIIandsourcescitedtherein. GAOReport,supranote153. 161 Id. 162 See,e.g.,JanetCurrie&ErdalTekin,IstheForeclosureCrisisMakingUsSick?,NBERWorkingPaperNo. 163 17310,August2011,availableathttp://www.nber.org/papers/w17310;G.T.Kingsleyetal.,TheImpactsof ForeclosuresonFamiliesandCommunities,WhitePaper,TheUrbanInstitute,May,2009,availableat http://www.urban.org/UploadedPDF/411909_impact_of_forclosures.pdf.

50

Growinghomevacancyratesalsoimposegreatpecuniaryandothercostsupon municipalities.164Althoughmostifnotallcountieshaveontheirbookslegalrequirementsthat ownersbeforeandafterforeclosuremaintaintheirproperties,asapracticalmatterthisdoesnt tendtohappen.165Partiesoneitherendofforeclosureshaveotherthingsontheirminds:The foreclosedparty,wheretogonext;theforeclosingparty,howinheavensnametoprocessall theremainingforeclosuresthatimpend. Theconsequenceisthatmunicipalitiesthemselvesmustmaintainordemolishthe propertiesinquestion.166Simplyboardingupabandonedpropertiestypicallycostshundredsto thousandsofdollarsperstructure.167Cuttinggrass,drainingswimmingpools,orremoving debrisentailssimilarcosts,someofthemrepeatedregularlyforeachproperty.168Demolition ultimatelyprovesnecessaryformanyproperties,andentailscostswellintothethousandsof dollarsevendoubledigitthousandsforeachpropertydemolished.169Someofthesecosts areoccasionedbythephysicalprocessitself,othersbytheadministrativeandjudicial requirementsthathavetobemetbeforeabsenteemortgageeownedpropertycanbesimply destroyed.170 Beforeabandonedpropertiesareproperlysealedoffordemolished,theyalsoimpose significantsafetycostsoncommunities.171Manyofthemactasattractivenuisances,to employthefamiliartortlawterm,tominorsandothers.Othersattractcriminalsandcrime, includingnotonlydrugdealingandprostitution,butmaterialsstripping,vandalismand arson.172Theserepresentnotonlycostsinthemselves,butalsocostsintheformofincreased lawenforcementexpenditureonthepartofaffectedmunicipalities. Abandonedpropertiesalso,ofcoursepartlyinvirtueofthetendenciesjustnotedbut alsoofthemselvesreducethevalueofsurroundingproperties,oftenthusleadingtofurther desertionandmigration:yetanotherselfworseningfeedbackorsnowballeffectoncea criticalmassofabandonedpropertiesisreached.173Thenumbersareoftenimpressive.One

164 165 166 167 168 169 170 171 172 173

Seesourcescitedsupra,notes153and163. GAOReport,supranote153. Id. Id. Id. Seesourcescitedsupra,notes153and163. GAOReport,supranote153. Seesourcescitedsupra,notes153and163. Id. Seesourcescitedsupra,notes153and163.

51

studyhasfoundthatevenasingleforeclosedhomedepressespricesofnearbyhomesfromjust underonetoashighas8.7percent.174 Again,thisisjustoneforeclosedhome.Anotherstudyfoundthatonedemolished homereducedthevaluesof13surroundingpropertiesby$17,000per.175Yetanotherstudy foundthatasingleforeclosed,vacanthomereducesthevalueofneighboringpropertiesby10 percent,andallhomeswithin500feetofitbyanaverageof.7%.176Onecouldproliferate referencestostudiesofthissortwithabandon,177butthepointispresumablymade,andisat alleventshardlysurprising. Alsohardlysurprisingisthatallofthisforeclosure,abandonment,andconsequentvalue lossresultsinmunicipalrevenueloss.178MunicipalitiesinAmericaoverwhelminglyfinance theiroperationsthroughpropertytaxassessments.179Losepropertydwellers,loseproperty values,andyoulosefundingallwhileneedingmoresuchfundingtohandlethecostswrought bytheabandonedhomesthemselvesaselaboratedabove.Andthisissonotwithstandingloan servicersbeingrequiredtokeepuppropertytaxpaymentsduringforeclosureproceedings.180 Ofcourse,somefederalprogramsareaimedatassistinghardhitlocalitiesinhandling thegrowingcostsdespitedwindlingrevenues.181Butthesedonotappeartobefunctioning wellandinanyeventsimplyrepresentshiftsofthecoststothefederalbudget,ratherthan eliminatingthesourceofthosecosts.182Whyonearthwouldthisbepreferredto municipalitiestakingchargeofandreversingtheirowndeclinesonbehalfoftheircitizensby pursuingtheMunicipalPlansketchedinSectionIII? Thecostsrunthroughthusfarallareattendantonactualforeclosureandactual vacancy.Butthereareadditionalcostswroughtbywhatmightbecalledshadowvacancy,if onemightbeforgivenforcoininganotherneologism.183Herewerefertothemuchlower

174 175 176 177 178 179 180 181 182 183

GAOReport,supranote153. Id. Id. Theyarecitedwithabandon(punintended)intheGAOReport,supranote153. Seesourcescitedsupra,notes153and163. Id. GAOReport,supranote153. Asdiscussedsupra,SectionII. Id. Byanalogytoshadowinventoryandshadowbanking.

52

investmentsofmoneysandlaborinhomeimprovementorhomemaintenancethat underwatermortgagorsmake.184 Thereasonsarenothardtofind.Foronethingthesemortgagors,strappedastheyare, areapttobeoutofthehousemoreeitherworkingextrahoursorseekingsuchwork.For anotherthing,insofarastheirunderwaterstatusinducesuncertaintyconcerninghowmuch longertheyarelikelytobeabletoholdon,itlikewiseinducesasearchforalternativeresidence andlivelihood. Finally,ofcourse,itwouldsimplynotseemtobeconsistentwithhumannatureto investonescareandconcerninahomethatonesensess/hemightverysoonlose.Forallof thesereasons,underwatermortgagedhomesdeterioratemuchmorerapidlythandoother homesevenwellbeforeforeclosure.Thesehomesareinacertainsensevacantalready,in thattheownersinmanycaseswillhavepsychologicallydetachedthemselvesfromthem. Heighteneddegreesofthissameformofdetachmentofcoursebringonwalkawayand strategicdefaultinsomecases.Itis,afterall,financiallyrationaltodefaultonanunderwater mortgage,sinceonetherebypayswiththelowervaluedassetratherthanthehighervalued principalamount.185 Thisofcourseleadsstraighttothecoststhatforeclosureandshadowforeclosure imposeuponlendersthemselves.Lendersnaturallyarewellawareofthesecosts,andforthat veryreasonareapttofavorprincipalwritedowns.Theproblemisthattheycannotcoordinate tosecurethem,forreasonscomprehensivelyadducedaboveinSectionII.Insofarassomeof theselendersthemselvesresideinthemunicipalitiesinquestion,countiesthatexercisetheir eminentdomainauthoritypursuanttotheMunicipalPlanactauthoritativelyontheirbehalves too.Andthisisofcoursenottomentionthesenseinwhichthesemunicipalitieswillact collaterally,ineffect,tothebenefitofallotherswhowishtoseeprincipalwritedownsaswell. Alloftheforegoingarewidelyappreciated,welldocumentedandwellquantified tendenciesnationwideinthemidstofourongoingandselfworseningmortgageforeclosure crisis.Allofthemlikewiseservetounderwriteanobviousandindeedexigentpublicpurpose onthebasisofwhichmunicipalitiescanexercisetheirtraditionaleminentdomainauthority pursuanttothePlanthatisthesubjectofthisMemorandum.Tosharpenthingsoncemore
184 Seesourcescitedsupra,notes153and163.AlsoGoodman,sourcescitedsupra,note61;andBrianT. Meltzer,MortgageDebtOverhang:ReducedInvestmentbyHomeownerswithNegativeEquity(August2010) (workingpaper,onfilewiththeauthor). Indeed,efficientbreachtheoriesofcontractrenegingsuchashaveproliferatedinconservative,law 185 andeconomicsapproachestocontractinsuchschoolsastheUniversityofChicagohaveitthatforgoingstrategic defaultisirrational.

53

withaspecificcasestudy,however,itmightbewellalsotosupplysomeoftheapplicable numbersforourpreviouslyselectedillustrativesamplestate,California,andoursamplecounty therein,SanBernardino.186Hereareafewofthenumbersinquestion.187 Conclusion:WhatsNext Wehavecoveredagoodbitofgroundhere.Butmuchmoreremainstobedone. Presumablythefinancialandlegalcasesformunicipalitiesandcognateauthoritiesembracing andactinguponplansliketheMunicipalPlanhavebeenfullymade.Whatremainsisfor specificmunicipalitiesnowtobegindoingso.Thatisapttobeginverysoon.Forthereare financialplannersandinvestorcoalitionsreadytobeginpartneringwiththehardesthit counties.Oncethesecountiesandtheirprivatepartnerscommenceproceedings,andonce theystartsucceeding,andoncewordgetsout,otherswillsurelybequicktofollow.Foritisthe solutionthatallofthemhavequiteliterallybeenwaitingfor. Inclosing,perhapsthefollowingobservationwillbeinorder.Wemightnothave turnedouttobetheoneswevebeenwaitingforiftheweinquestionisourpresently operationallychallengedfederalgovernment.Butweindeedaretheoneswevebeen waitingforifwebeourowntownsandneighborhoodsifwebethepeopleinthatmuch moreconcreteandvisceral,ratherthandiffuseandabstract,sensethatagreatobserverof Americanlifeoncesuggested.TheobserverinquestionwasAlexisdeTocqueville,whosaid,in effectwellbeforeaquotableformerFirstLadydidthatinAmerica,ittakesavillage.It wouldseemhewasright.
186 ForreminderofwhySanBernardino,Californiamakesforanillustrativecasestudy,pleaseseesupra,note 54,andaccompanyingtext. Figuresforthcoming. 187

54

 TechnicalAppendixA:MortgageSelectionandFairValuationMethodologies TechnicalAppendixB:FurtherJurisdictionalandOtherLegalDetails

55