A city-commissioned report (pdf) presented today before the City Council's Housing, Human Services, Health and Culture committee finds that approximately 42,000 Seattle homeowners—about a third of city residents with mortgages—are "underwater," with loan balances exceeding the value of their homes by an average of $92,000. This "negative equity" leaves borrowers unable to refinance or sell their homes, and thus only a lost job or an illness away from foreclosure, and potentially homelessness. And thanks to predatory lending practices during the real estate bubble, it's a foreclosure crisis that disproportionately affects communities of color.
The report, authored by Cornell Law School Professor Robert Hockett, goes on to recommend three creative options for addressing this crisis, and helping those in or facing foreclosure to keep their homes:
Lease Swaps. Chapter 13 of the federal bankruptcy law specifically bars bankruptcy judges from "stripping down" the portion of the loan that exceeds the value of one's primary residence, an exemption that does not apply to investment properties. And so Professor Hockett proposes that underwater homeowners with houses of comparable value could get around this exemption by swapping houses at a fair market lease rate, so that borrowers no longer live in their own homes, and thus no longer own their primary residence. It's a clever end run around the bankruptcy law, but one that has yet to be fully tested in court. Hockett says that the city could promote and facilitate lease swap arrangements while taking on no liability.
Eminent Domain. Hockett argues that while writing down the principal on underwater loans could financially benefit both debtors and creditors alike, trustees of securitized loans are often prohibited by contract from even considering this option. So the city could use its eminent domain authority to seize the mortgages, paying their fair market value, and then rewrite the loans to leave homeowners with positive equity. Hockett suggests that the loan trustees may even be willing to finance these takings and buy the rewritten loans back, thus replacing non-performing loans with ones unlikely to end in foreclosure. (It is important to note that we are talking about using eminent domain to take the mortgages, not the homes themselves.)
Municipal Land Bank. While the previous two options are intended prevent foreclosure, a land bank is a public authority, created by ordinance to hold, manage, and redevelop tax-foreclosed properties. It uses the city's eminent domain or tax-foreclosure authority to take homes that are in foreclosure, and then potentially rent and/or sell them back to the original homeowner. This is the least experimental of the three options, as it is already being used in a number of cities.
Two observations. First, no doubt critics will take note that due to the lack of access to proprietary data, some of Dr. Hockett's estimates of the severity of Seattle's foreclosure crisis are educated guesses. But that's not important. Whatever the size of the crisis, it remains no less severe for those who are in it. And so the city has an obligation to attempt to do what's best for its citizens.
Second, as experimental as these proposed solutions may be, they are at least worth exploring. The fact that lease swaps have yet to be fully vetted in court, or that the eminent domain strategy is currently facing legal challenges in Richmond, California, should not dissuade the council from giving these options serious consideration. Just because something hasn't been done, doesn't mean it can't be done. So the council deserves credit for taking a creative approach to an ongoing crisis faced by thousands of Seattle homeowners.