Gayle McLaughlin, the mayor of Richmond, Calif., is threatening to use the citys power of eminent domain to seize 624 mortgages from banks that are unwilling to sell these mortgages to the city. This brazen attack on property rights and the sanctity of contracts will ultimately harm the citizens of Richmond. This threat is also the latest in a long string of governmental abuses that are undermining the security of property rights in the United States.
Almost half of the mortgages in Richmond are underwater, where homeowners owe more on the mortgage than the current market value of the home. The city is offering to buy the mortgages from banks at prices below the current market value and then to work with Mortgage Resolution Partners (MRP) to offer existing homeowners a new mortgage at a value between the citys purchase price and the current market value. The city and MRP would split the profits and the homeowner would no longer be underwater.
Sounds great. Right? But heres the catch: the city has sent out more than 600 offers and the banks arent biting. Why should banks sell to the city? Not all of these mortgages are in default. Some owners are still paying what they owe. Even when owners dont pay, banks could foreclose and try to collect market value for the home rather than the lower amount the city is offering.
McLaughlins answer, rather than sweetening the offer to get the lenders to agree, as people have to do in private markets, is to use the governments power of eminent domain to force the banks to sell. Wells Fargo and other banks filed a lawsuit to prevent the seizures.
Will it help the citizens of Richmond if the city is successful in forcibly seizing the mortgages and re-writing them? In the short run, sure. Current home owners will rid themselves of some debt without damaging their credit. But as Henry Hazlitt long maintained, good economic analysis considers both the obvious short-run benefits (and costs) and the long-run consequences of any particular policy.
If Mayor McLaughlin delivers on her threat, banks will view mortgage lending in Richmond as a riskier investment. As a result, banks will make it harder to get loans in Richmond by requiring higher down payments to minimize the risk of the mortgage going underwater. They will also likely demand higher interest rates to compensate for the increased risk of lending in that market. Certain banks may curtail all of their lending in Richmond. These consequences will almost surely outweigh any short-run gain that might be achieved by using eminent domain.
According to Wells Fargo, Newark (NJ), North Las Vegas, El Monte (CA), and Seattle are all considering similar plans. Taken together, they will further contribute to the decline in the security of property rights in the United States and further jeopardize our economic prosperity.
The overall trend is not a new phenomenon. The security of our property rights and contracts has been on the decline in the United States for more than a decade. One example of this decline is the 2005 U.S. Supreme Court ruling in Kelo v. City of New London that ruled that it is constitutional for a city to use eminent domain to take private property from one person and transfer it to another private party for the purpose of economic development.
Other prominent instances of the weakening of our property rights include the governmental forced re-writing of contracts during the 2008 financial crisis. For example, the Fed paid off banks holding mortgage- backed securities with AIG in exchange for the dissolution of the contracts. This prevented banks from terminating the contracts and collecting their collateral.
According to the Economic Freedom of the World Annual Report, the security of our property rights and integrity of our legal system have declined by 23 percent since 2000, plunging the United States world ranking from 9th to 33rd. Not only do other wealthy countries like Switzerland and Canada rank ahead of the United States in the protection of property rights, but so do Botswana, Morocco, Malaysia, and Kuwait!
The protection of private property rights and a legal system that upholds contracts are the bedrock that forms the foundation for a stable and prosperous free enterprise system. Unfortunately, Mayor McLaughlins plan is only one among many government actions that are undermining that bedrock in the United States. The United States needs to change course and better respect private property and contracts if we are to continue to enjoy our relatively high standards of living and expectation of continued prosperity.