City leaders in Richmond have developed a new plan to use eminent domain -- compulsory acquisition by the government -- to help local underwater homeowners. Their basis for this action is the claim that falling household values are not the fault of homeowners, but rather of greedy financial institutions.
Program advocates believe that the program uses the power of government to create a win-win for homeowners and the city. Unfortunately, this program only creates losers.
The program began in late July when the city sent offers on 624 "underwater" mortgages to the banks that service them. The city offered to pay 80 percent of a home's current value. For example, a home currently worth $400,000, but with $600,000 in outstanding mortgage debt, garnered an offer of $320,000.
Unsurprisingly, the banks rejected these offers as a very bad deal. The majority of the 624 underwater mortgages had owners making steady payments, and the rest could easily be sold for more than $320,000 at a foreclosure sale.
Unhappy, the city then proceeded to condemn the properties under its power of eminent domain. Its partner in crime was Mortgage Resolution Partners, a private company seeking compensation of $4,500 per property refinance. This company had an obvious incentive to see these homes condemned -- it stood to gain a cool $2.8 million from the 624 cases.
Lost in this real-life game of Monopoly are the rest of the city's homeowners, whose homes and mortgages were not underwater. It turns out that their years of prudent investments and wise financial choices were wasted; they could have just waited for the city's bailout rather than pay their monthly mortgage.
Instead, their caution and wisdom cost them more, and some of their tax money went to pad the pockets of a private company.
The city's bailout thus has the unintended consequence of encouraging future homeowners to act recklessly in the hope that the city will come to their rescue if things turn sour.
This also forces lenders and banks to change the way they do business. To avoid the possibility of future underwater homes, lenders will require higher down payments, raise interest rates, or avoid lending altogether. This has the perverse effect of making homeownership harder for everyone -- particularly the poor.
Thus, the city will end up exacerbating the problems that its actions were supposed to fix, while creating new problems in the process.
Unfortunately, this is the natural result of years of government policies that unduly favored affordable housing. Policies ranging from lower down payments to lower mortgage rates to first-time borrowers quickly raised demand for housing that eventually contributed to a full blown housing bubble. The bubble, in turn, created the underwater mortgages that have led us to where we are now.
At least there's one winner: Mortgage Resolution Partners. This private business now stands to pocket the profits of the government's housing decisions, even as homeowners are set to suffer.
And that's the real lesson to be drawn from Richmond's eminent domain bailout. The collusion between "big business" and "big government" is becoming increasingly common, and constant government interference in the housing market directly contributes to the problem.
Whether it's Mortgage Resolution Partners or Fenway Summer -- the finance company founded by a former Consumer Financial Protection Bureau commissioner who now sells the same products he was supposed to regulate -- the line between serving the public service and corporate self-service is too blurry to discern.
When Richmond's decision backfires and the city steps in with another scheme that will harm more people than it helps, there's sure to be a company that can turn a profit off the city's short-term thinking.
Michael L. Marlow, Ph.D., is professor of economics at California Polytechnic State University.