Among the many concerns San Bernardino County’s recent eminent domain proposal highlighted, one that stood out to me was the larger problem with second liens.
Second liens keep coming up as one of the post-downturn elephants in the room. They’re a quieter issue than, say, the question of what’s going to happen to Fannie Mae and Freddie Mac, but they’re still pretty big.
There is nothing like a second lien to throw a monkey wrench into a mortgage investment’s value over time, at least the loan-to-value component of it.
As one industry executive put it at the Mortgage Bankers Association’s secondary market conference in New York earlier this year: one day you buy a loan and it’s got a 70% loan-to-value ratio, a year later someone takes out a second mortgage and you’ve got a 100% LTV. It’s basically unsecured.
At that point you better hope your borrowers psychologically value their home enough to keep paying even when they have no equity.
People have looked into doing something about this, but it is not an easy problem to fix.
Why? In case you don’t already know, it’s because the vagaries of second liens are “the law.”
In 1982, the Garn-St Germain Depository Institutions Act got enacted and I’ve been told that among other things it, roughly put, says there can be a second lien put on a first lien at just about any time without telling the first lien holder. This was done in such a way that it would take a lot to change that legally.
The county proposal could theoretically make this already-challenging situation for investors worse by allowing a governmental entity to buy second liens at a “fair market value” determined without investors’ input.
To add insult to possible injury, this would happen a time when the borrowers haven’t even missed a payment.
As the Credit Suisse researchers Chandrajit Bhattacharya and Marc Firestein noted in a report last week, something should be done about the fact that more than half the borrowers in the county have negative equity.
But this may not be the best approach.
The researchers question how much of a priority it is for the county to reduce this negative equity for borrowers who are able to pay.
This is important to determine because eminent domain seizure requires a public purpose be served.
“Borrowers who are still current do not pose any urgent risk to the county’s fiscal and housing problems, in our view,” the researchers said.
Is this enough of a reason to, as the Credit Suisse report puts it, “set a precedent in which eminent domain powers will be used for the first time to renegotiate debt between private parties,” something that usually is decided in court?
I do think something should be done to help the area.
In that light, I’m glad this proposal has been aired in order to draw more attention to it.
Hopefully it will lead to some more optimal solution that is less potentially disruptive to the market.