Thursday, August 29, 2013

Eminent Domain Got More Exciting

I am just starting to get my head wrapped on this issue. That said, the events emanating from Richmond, Ca bear watching. Eminent domain in the U.S. has been around a few years, first causing an uproar when the practice upended private property rights following lawsuits that culminating with a review by the supreme court. Now, the city of Richmond goes one step further...... as detailed in the video below.

But is this use of eminent domain that bad? Commentators at Bloomberg don't seem to think stating....

To judge from the disparaging reaction to its plan to use eminent domain to cope with underwater homes, you'd think the city leaders of Richmond, California, had proposed an outrageous and unprecedented distortion of state power.

Filing suit against Richmond, BlackRock Inc., Pacific Investment Management Co. and other plaintiffs alleged that the city's proposal amounts to an “unconstitutional application of eminent domain” and a “brazen scheme.” The Federal Housing Finance Agency announced that it was considering ceasing to do business in municipalities that pursue this course. Media coverage generally echoed the plaintiffs’ take. USA Today’s headline summed up the conventional wisdom, declaring that Richmond “runs amok with eminent domain.”

In fact, the city's plan relies not on a novel use of eminent domain but on one endorsed by the conservative Supreme Court of 1935. And although there is a long history of excessive use of eminent domain, Richmond's plan has no place in it. Richmond's plan is to seize 624 mortgages valued at more than the homes for which they were written. Relying on a private intermediary, the city would compensate the investor holding a mortgage at a price reflecting the home's current value rather than an inflated bubble value. The city would then sell a more modest loan to the homeowner. Richmond hopes this will induce residents to remain in their homes and pay their mortgages and property taxes. Proponents of the plan also point out that this probably will lower the risk of default, protecting investors holding the mortgages.

Nonetheless, the big players in the bond markets are angry that they’re being forced to accede to the demands of a small city in California. Before they fight city hall, the plaintiffs should appreciate that use of eminent domain to seize intangible assets like mortgages has a solid history. Federal courts have long sanctioned the taking of everything from shares of stock to contract rights, insurance policies and even hunting rights.

Consider a famous Supreme Court case from the Great Depression. During that crisis, banks foreclosed on farmers who fell behind on their mortgage payments. In response, Congress passed the Farm Bankruptcy Act granting farmers five years to negotiate a reduction in the principal of their loans. Farmers were entitled to buy the property at the current appraised value, even if it fell short of the value attached to the original mortgage.

Then, as now, banks didn’t like the policy and went to court, arguing that it violated their property rights, as guaranteed under the Fifth Amendment. In May 1935, the Supreme Court overturned the law in a unanimous decision, the first of several such rulings that made the court into a conservative counterweight to the New Deal. Nevertheless, in the final paragraph of its decision, the court laid out an alternative course for just the kind of remedy the Farm Bankruptcy Act had sought.

The Bloomberg's commentators opinion could not be more wrong. The Great Depression was 'great' because of, and not in spite of' government interventions in the market. By intervening now as then, the pricing mechanism becomes distorted and feedback loop/informational signals inherit in unfettered prices are rendered usable. This dynamic short circuits market forces and prolongs not only the correction but the economic hardships. As Rothbard boldly proclaimed, the depression is the recovery.

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