Wells Fargo Bank, National Association et al v. City of Richmond, California et al

Filing 9

Declaration of John Ertman in Support of 8 MOTION for Preliminary Injunction filed byDeutsche Bank National Trust Company, Deutsche Bank Trust Company Americas, Wells Fargo Bank, National Association. (Attachments: # 1 Exhibit A, # 2 Exhibit B, # 3 Exhibit C, # 4 Exhibit D, # 5 Exhibit E, # 6 Exhibit F, # 7 Exhibit G, # 8 Exhibit H, # 9 Exhibit I, # 10 Exhibit J, # 11 Exhibit K, # 12 Exhibit L, # 13 Exhibit M)(Related document(s) 8 ) (Tsai, Rocky) (Filed on 8/8/2013)

EXHIBIT E

Memorandum of Law and Finance

Breaking the Mortgage Debt Impasse: Municipal Condemnation Proceedings and
Public/Private Partnerships for Mortgage Loan Modification, Value Preservation,
and Local Economic Recovery
Robert Hockett *
Introduction: It Takes a Village
Six years after residential real estate prices peaked and then plunged, U.S. primary and
secondary mortgage markets continue to languish in self-worsening slump. 1 As the modifying
phrase “self-worsening” suggests, feedback effects constitute a critical component both of the
problem and of its stubborn persistence.2 These effects operate both as between property
prices and mortgage default rates, and as between primary and secondary mortgage markets
and broader local and regional economies. 3
As it happens, the mentioned feedback loops are themselves critically mediated through
uncoordinated market decisions taken by multiple actors who face formidable collective action
hurdles – hurdles that can prevent forward or hasten backward movement by endowing
individual expectations with significant “self-fulfilling prophecy” properties. 4 These latter are
the source of the aforementioned “feedback” effects – effects that can amplify optimism into
dysfunctional bubble or boom, and pessimism into bust and protracted depression.5
*

Professor of Law, Cornell Law School; Fellow, The Century Foundation. Particular thanks to Greg
Alexander, Mike Campbell, Nestor Davidson, Mike Dorf, Bob Frank, Bill Frey, Howell Jackson, Bob Litan, Lynn
Lopucki, Eduardo Peñalver, Bob Shiller, David Skeel, Lynn Stout, Joe Tracey, and Laura Underkuffler. Special thanks
to Saule Omarova. Last and anything but least, thanks to my frequent collaborator Daniel Alpert. Thanks as well to
my other, unnamed colleagues at Cornell, TCF, and other institutions. Opinions expressed herein are those of the
author and not properly attributable to his affiliates absent express confirmation. Indeed there are differences on
some points between some of those here named and the author. Readers should also be advised that the author is
disinterested in what he is here recommending, but may subsequently undertake more legal, financial or
expository work in connection with the proposals offered and advocated herein.
1
Telling statistics are supplied in abundance below, Section II.
2
The structural dynamics are laid out below, Sections I and II.
3
Id. Mortgage markets causally interact with the broader economy with particular force because homes
are the principal form that wealth takes among that broad American middle class upon whose healthy consumer
expenditure both economic growth and employment depend. See Robert Hockett, Six Years On and Still Counting:
Sifting Through the Mortgage Mess, 9 HAST. BUS. L. J. __ (2012) (forthcoming). More again, infra, Sections I and II.
4
Classic cases in point are bank runs (before deposit insurance), hyperinflations, and liquidity traps. See
again infra, Sections I and II. Also Robert Hockett, Recursive Collective Action Problems, 5 J. APP. ECON. __ (2012).
5
The one typically follows the other, with assets symmetrically undervalued by uncoordinated markets
during busts just as they have been previously overvalued by uncoordinated markets during antecedent booms.
See Hockett, id.; also Robert Hockett, A Fixer-Upper for Finance, 87 WASH. U. L. REV. 1213 (2010).

1

Because the hallmark of such “recursive collective action problems,” as we shall here
call them, is their aggregating multiple individually rational decisions into collectively selfdefeating and even self-worsening outcomes,6 their solution requires the presence of a
collective agent empowered to act on behalf of all parties to optimize joint outcomes. 7
Against this structural backdrop, some acute observers have come to recognize that
some such “collective agent” will be required to solve that collective action challenge which lies
at the heart of that self-worsening slump which continues to afflict U.S. local and regional
mortgage markets – and, through them, our local, regional, and hence national economies. 8
The question is, what person or entity is best situated to discharge this critical function?
For a number of reasons comprehensively elaborated below, 9 many though not all of
them rooted in the inherently state-centered character of contract, commercial, trust and real
property law under our constitutional order, 10 the federal government and its instrumentalities
are not now well suited to this task. 11 At best they are but complementarily situated.
6

See again infra, Section II. The term “recursive collective action problem” is introduced in Robert Hockett,
Bretton Woods 1.0: An Essay in Constructive Retrieval,” 16 N.Y.U. J. LEGIS. & PUBLIC POL’Y __ (2012) (forthcoming).
Also Hockett, Recursive Collective Action Problems, J. APP. ECON., supra note 4. These problems’ defining feature is
their “spiraling” tendency – upward (as in inflations) or downward (as in bank runs and slumps) – as rooted in
uncoordinated, “self-fulfillingly prophetic” individual decisions. More, again, infra, Section II.
7
See sources cited supra, notes 4 through 6. This will also be an apt place to note that we shall often lump
“coordination” and “collective action” challenges together, notwithstanding their subtle distinctions. We do so
partly for reasons of simplification that does no harm in the present context, and partly because collective agents
address both kinds of challenge.
8
See, e.g., Federal Reserve Board, The U.S. Housing Market: Current Conditions and Policy Considerations,
White Paper, January 4, 2012, at 3; and William C. Dudley, “Housing and the Economic Recovery,” Remarks at the
New Jersey Bankers Association Economic Forum, January 6, 2012, available at
http://www.newyorkfed.org/newsevents/speeches/2012/dud120106.html.
9
See again infra, Section II.
10
See infra, Section IV, for more on our state-centered federal system and the reservation of contract,
commercial, and especially trust and real property law to the states pursuant thereto.
11
In addition to Section IV, Section II, in which the failures of the FHFA, the GSEs, HAMP and HARP are
explained, is germane to this point. I hasten to note here that Howell Jackson proposed a resolution to the crisis
using Tarp moneys and eminent domain authority as early as 2008. See Howell E. Jackson, Build a Better Bailout,
CHRISTIAN SCIENCE MONITOR, September 25, 2008, available at
http://www.csmonitor.com/Commentary/Opinion/2008/0925/p09s02-coop.html.
The author of this Memorandum proposed something similar, in this case employing TARP moneys to
fund FHA purchases of voluntarily relinquished troubled mortgages, which he suggested would be forthcoming in
abundance owing to distressed market conditions. FHA would thereby itself be solving a collective action problem
then underwriting (fragmented) market undervaluation of the mortgages in question. See Hockett, Bailouts, Buyins, and Ballyhoo, 52 CHALLENGE 36 (2009), elaborating more fully on proposals made by author in several op-eds
over the autumn of 2008.
For reasons adduced infra, Sections II and IV, I think that at this point the local route is more promising
than the federal, as well as, for reasons adduced infra, Section III, less costly to the public fisc. (The Plan proposed

2

States and their instrumentalities – their municipalities in particular – are by contrast
very well situated to play the appointed role.12 That in turn raises the question by what means,
and under what legal and constitutional authority, states and their municipalities might best
discharge this critical function.
This Memorandum addresses and answers that question. The answer it reaches is that
traditional state eminent domain authority, as typically delegated in turn by the states to their
municipalities and cognate authorities, is by far the best ground upon which to act. The
Memorandum also finds that a combined condemnation and mortgage restructuring plan of a
particular form will be by far the best legally and financially feasible option. We shall call this
“the Municipal Plan” (or “the Plan”).
The Memorandum proceeds as follows. Section I describes the source and structural
dynamics of the ongoing mortgage crisis still facing the nation, its states, and their
municipalities.13 Section II then outlines the general form that solutions to crises of this kind
must take – a form that corresponds to the structure of the crisis itself. Section II also explains
why no such solution has yet been forthcoming.14 In essence, it indicates, coordination hurdles
of the same form as rendered the crisis possible now render its solution impossible, absent
some duly authorized collective agent able to act on behalf of the interested parties – a role, as
just noted, that municipalities are best situated to play.
Section III then details the Plan mentioned above, indicating both how its structure
responds point for point to the structure of the crisis, and how its use of the eminent domain
authority capitalizes on municipalities’ optimal positioning for purposes of collectively
addressing the coordination challenges that now underwrite ongoing mortgage inertia. 15 It also
emphasizes the role of public/private partnering between municipalities and lenders – including
lenders who currently hold mortgage debt – in the Plan. It emphasizes how this feature
enables municipalities to proceed at no cost to the public fisc – another important advantage,
particularly in strapped times such as these.

here is investor-funded.) The author continues to think along his own earlier, as well Professor Jackson’s, lines,
however, in finding that federal action would still make for a welcome complement. See again infra, Section II.
12
As explained more fully infra, Sections III through V.
13
Commencing at page 4.
14
Commencing at page 15.
15
Commencing at page 28. Appendix A, which complements this Section, provides fuller financial detail for
those possessed of more specialized transactional knowledge in the form of a sample hypothetical term sheet.

3

Section IV comprehensively lays out the legal and constitutional basis of the Plan,
indicating how the latter carries out precisely that purpose which underlies the traditional state
eminent domain authority. 16 Section V then catalogues the immensely destructive spillover
consequences – for borrowers, lenders, neighborhoods, families, local property values and
assessments, local revenue bases, state and local economies, social services, crime rates, and
more – of further delay in addressing the crisis.17 Prevention of all of these consequences, it
indicates, constitutes precisely that exigent public purpose for which state eminent domain
authority exists in our law.
Although this Memorandum constitutes an integrated whole, readers who are
interested primarily in the Plan’s financial and economic details and rationale will wish to focus
particularly on Sections I through III. Readers who, by contrast, are interested primarily in the
Plan’s constitutional basis and legal-procedural detail should focus particularly on Sections III
through V.
Because the applicable law referenced here is, by its terms, particularly solicitous of the
financial, broader economic, and attendant necessities faced by localities in extremis, however,
and is indeed part of our federal system precisely in order to afford these localities means of
efficient address of the same, the financial and economic analysis of the earlier Sections cannot
but inform the specifically legal and constitutional analysis of the later Sections. It is hoped,
then, that at least some readers will read all that follows rather than cherry-picking.
On that integrative note, the Memorandum’s Conclusion ties up loose ends and looks
forward.18 Against the backdrop of up to ten or more million impending foreclosures to come
in the very near future,19 it suggests, we are apt to see many municipal condemnation actions,
brought pursuant to sundry specific, locally responsive, finely tuned variants of the Plan here
described, in the months just ahead.

I. The Present Crisis – Root Causes and Structural Dynamics
As observed above in introducing the present discussion, the nation, the states, our
cities and even the globe remain trapped in the fallout of a financial crisis whose epicenter
16

Commencing at page 35. Appendix B, which complements this Section, provides fuller legal and
constitutional detail for those possessed of more specialized legal-procedural and doctrinal knowledge in the form
of a sample hypothetical filing and supporting brief.
17
Commencing at page 48.
18
Commencing at page 54.
19
See again infra, Section II, for this and additional telling statistics. Also Section V.

4

comprised and comprises a not very large number of U.S. localities.20 The crisis itself was the
culmination of a decades-long credit-fueled asset price bubble that focused primarily on
residential real estate. The latter for its part both was, and remains, disproportionately located
in Florida, California, and several additional “sun belt” or “sand” states.21
The credit in question, for its part, stemmed in the main from persistent, historically
unprecedented trade surpluses that were accumulated over more than a decade by heavily
low-wage-labor-endowed new entrants to the liberalized global economy following the
breakup of the old “eastern” bloc of erstwhile socialist nations. 22 Flows of this credit were
particularly difficult, if not indeed impossible, for domestic monetary authorities like the U.S.
Federal Reserve to “sterilize,” given the openness of U.S. financial markets to the wider world.23
The theretofore unprecedented “global savings glut,” as then Federal Reserve Governor
Ben Bernanke christened it in 2005, 24 served as the predicate to a classic recursive collective
action problem of the kind noted above in introducing this Memorandum. The hallmark of
these problems, again, is their capacity to bring about situations in which multiple
uncoordinated decisions – even blameless, individually rational such decisions – aggregate into
collectively self-damning outcomes. 25
Arms races, “bums’ rushes,” bank runs and busts are familiar examples of this common
phenomenon – as are, in non-recursive form, those game-theoretic perennials known as the
“prisoner’s dilemma” and “tragedy of the commons.” 26 So too, we now know, are asset price
bubbles and busts. 27
20

As more statistics related infra, Section II reveal, affected communities are disproportionately, though
certainly not solely, located in Florida, California, and neighboring southwestern states. In this sense, the situation
is not unlike that which followed the nation’s last residential real estate bubble and bust, in the late 1920s. See
Hockett, A Fixer-Upper for Finance, supra note 5; also Hockett, Bailouts, Buy-Ins, and Ballyhoo, 52 CHALLENGE 36
(2009).
21
See supra, note 20. Also infra, Section II, for relevant statistics.
22
Notably China and the East Asian “tiger” economies, but also others. See Daniel Alpert, Robert Hockett,
and Nouriel Roubini, The Way Forward: Moving Past the Post-Bubble, Post-Bust Economy to Renewed Growth and
Competitiveness, White Paper, New America Foundation, October 2011.
23
See Alpert, Hockett, & Roubini, The Way Forward, id. Also Hockett, Bretton Woods 1.0 supra note 6.
24
See Ben S. Bernanke, The Global Savings Glut and the U.S. Current Account Deficit: Remarks at the
Sandridge Lecture, Virginia Association of Economists, March 10, 2005, available at:
http://www.federalreserve.gov/boarddocs/speeches/2005/200503102/.
25
See Alpert, Hockett, & Roubini, The Way Forward supra note 22; also Hockett, A Fixer-Upper for Finance,
supra note 5; and Robert Hockett, Bubbles, Busts, and Blame, 37 CORNELL L. FORUM 14 (2011).
26
See sources cited id. The standard renditions of the prisoner’s dilemma and tragedy of the commons do
not involve feedback effects and accordingly need not be self-worsening. Indeed, collective action-problemsolving conventions can sometimes emerge pursuant to iteration of these situations. What we are calling recursive
collective action problems, by contrast, simply self-worsen with iteration, hence involve either indeterminate

5

The problem in the present instance, with whose sequelae a comparatively small
number of U.S. municipalities continue disproportionately to struggle, unfolded on the one
hand pursuant to the classic familiar pattern, while on the other hand on the strength of the
historically anomalous global credit glut just noted. 28 For as long as that surplus of credit
remained disproportionately attracted to U.S. dollar-denominated assets – as, given the unique
global role of the dollar, it was bound to do for as long as our trading partners declined to
recycle them at home 29 – borrowing costs in this country could not but remain low. 30 And so
they did, for well over a decade.31
But when credit costs – in the form either of low interest charges or high obtainable
loan-to-value ratios (LTVs) – remain inexpensive over some lengthy interval, and at some point
early on in that interval some discrete class of assets like real estate and the financial
instruments appurtenant to it begin rising in value, for whatever exogenously given reason, at

equilibria or no equilibria at all. See again Hockett, Recursive Collective Action Problems, supra note 5; and
Hockett, Bretton Woods 1.0, supra note 6..
27
Some of course do not simply “now” know this, but long in effect have observed it. See sources cited
supra, notes 25 and 26. See also the work of Geanakoplos cited infra, note 33; and the important work on
procyclicality in the monetary and financial systems of my colleague Tobias Adrian with Hyun Shin, e.g. Tobias
Adrian & Hyun Song Shin, Procyclical Leverage and Value at Risk; FRBNY Staff Reports, No. 338 (2011), available at
http://www.newyorkfed.org/research/staff_reports/sr338.html; Tobias Adrian et al., Monetary Cycles, Financial
Cycles, and the Business Cycle, FRBNY Staff Reports, No. 421 (2010), available at
http://www.newyorkfed.org/research/staff_reports/sr421.html; and Tobias Adrian et al., Financial Intermediation,
Asset Prices, and Macroeconomic Dynamics, FRBNY Staff Reports, No. 422 (2010), available at
http://www.newyorkfed.org/research/staff_reports/sr422.html. See also HYUN SONG SHIN, RISK AND LIQUIDITY (2010).
28
See Alpert, Hockett, & Roubini, The Way Forward, supra note 22.
29
The reasons for hoarding dollar denominated assets have included, inter alia, foreign exchange holding for
defense against possible speculative attacks upon domestic currencies of the kind that characterized the Asian
Financial Crisis of the late 1990s, domestic inflation prevention in the high growth rates at home, possible currency
manipulation in order to maintain exports, and other, less pressing imperatives. See Alpert, Hockett, & Roubini,
The Way Forward, supra note 22; and Hockett, Bretton Woods 1.0, supra note 6. Also MARTIN WOLF, FIXING GLOBAL
nd
FINANCE (2 ed., 2010).
30
See sources cited supra, notes 22, 23, and 24. Please note that, for the time being at least, with the term
“borrowing costs” I am lumping together credit of the form extended in return for interest payments on the one
hand, and credit that varies with available leverage ratios as determined by varying collateral requirements on the
other hand. There are some contexts and associated purposes for which it is important to distinguish them, for
reasons very well conveyed by Geanakoplos in the sources cited just below, note 33. For the moment, the present
context is not one of them.
The Fed in during the era to which we here allude might have been able to do more by way of reining in
credit, including through interest rate policy or, more potently, the regulation of leverage ratios. But there were
reasons for it to be cautious about doing so, and the free inflow of credit from abroad under liberal global financial
arrangements would have rendered the task both delicate and difficult in any event. See, e.g., Alpert, Hockett, &
Roubini, The Way Forward, supra note 22; Hockett, A Fixer-Upper for Finance, supra note 5; and Hockett, Bretton
Woods 1.0, supra note 6.
31
See again sources cited supra, notes 22, 23, and 24.

6

more rapid rates than the effective interest or collateral haircut rates, it quickly becomes
rational for more individuals than before to begin borrowing and buying the assets in question.
Moreover, and more ominously for present purposes, it also becomes rational for at
least some individuals – so-called “speculative buyers” – to borrow to buy only to sell, with a
view ultimately to profiting on the emerging, then widening spread between low borrowing
costs and high, then accelerating capital appreciation rates.32 And these comparatively few
speculative buyers, crucially, come increasingly to determine the prices that even conservative
buyers must pay – and indeed borrow to pay. 33
Once even a relatively small threshold number of speculative market actors begin acting
on rational “spread-legging” calculations like these, the ensuing credit-fueled asset appreciation
process can become self-accelerating. It can do so, indeed, for as long as the credit that fuels it
remains overabundant. More buying then comes to mean more price rises, which means
greater spreads between low levering costs and high capital gains, which in turn brings on more
expectation of yet further price rises, which issues in further accelerated buying 34 – and so on,

32

See sources cited supra, note 25. The assets in question might first begin (moderately) rising in value for
reasons rooted in “fundamentals” – for example, demographic changes that bring more first-time buyers into
housing markets. The problem is that over-abundant credit can then enable even initially moderate price rises
rooted in fundamentals to accelerate into much steeper price rises rooted in credit-enabled, self-fulfilling price-rise
expectations themselves.
33
This point is critical, particularly when questions of blame are on the agenda. One needed not be a
“house-flipper” to get caught up in and thus inadvertently further contribute to the mortgage bubble dynamic, any
more than one need be a “bread-flipper” to be drawn into and thereby contribute further to the dynamic of a
consumer price hyperinflation. Perfectly sober, even regretful parties can be prompted to buy now rather than
later simply by rational recognition of the fact that, so long as the inflation or hyperinflation is underway, prices
will be so much higher in future as to render it sensible to buy now rather than later. It also bears noting that not
only speculators, but fraudsters as well can disproportionately determine these higher market prices that the great
majority of sober and honest purchasers must pay. See Hockett, A Fixer-Upper for Finance, supra note 5; Hockett,
Bubbles, Busts, and Blame, supra note 25; and Hockett, Recursive Collective Action Problems, supra note 6.
Credit for first rigorously modeling the disproportionate influence of “optimists” in a general equilibrium
model with heterogeneous investors rests with the prescient and ever-brilliant John Geanakoplos. See John
Geanakoplos, Promises, Promises 305-07, in THE ECONOMY AS A COMPLEX EVOLVING SYSTEM II, pp. 285-320 (W. B. Arthur
et al., eds., 1997); John Geanakoplos, Liquidity, Default, and Crashes: Endogenous Contracts in General Equilibrium,
in ADVANCES IN ECONOMICS AND ECONOMETRICS: THEORY AND APPLICATIONS, ECONOMETRIC SOCIETY MONOGRAPHS, EIGHTH WORLD
CONFERENCE, 2:170 (Cambridge U. Press, 2005); and, more recently, John Geanakoplos, The Leverage Cycle, NBER
MACROECONOMICS ANNUAL, pp. 1-65 (2010), at 43. The same works highlight the importance of distinguishing
between interest and leverage (collateral) in some critical contexts. They do not reference fraudsters, but the logic
carries over to their case as well.
34
Note again that the accelerated buying might be done by speculators or fraudsters acting pursuant to
profit motives, but also might be done by ordinary “buy and hold” buyers who simply decide to buy sooner rather
than later in order to avoid having to pay more at later dates. In this sense the bubble is, again, much like a
consumer price hyperinflation, which can be fueled not only by commodities speculators but also by ordinary
consumers hoping to preempt higher payment requirements apt to set in at later dates.

7

for as long as (1) the levering remains inexpensive, and (2) there remain further, untapped
prospective new entrants to affected markets. 35
And again, it bears emphasis, the comparative minority of speculative buyers in these
circumstances increasingly determine the prices that all entrants must pay. Even cautious new
“buy and hold” purchasers who would have entered the home markets in any event – a young
couple or new family seeking their first home, say – effectively fall hostage to the decisions of
levered-up “house-flippers” whose purchases the credit glut renders prospectively profitable.36
The real estate bubble of the later 1990s and early 2000s was self-accelerating pursuant
to precisely this “feedback loop” pattern. As more investors noticed the profits to be made by
purchasing residences, mortgage-backed securities (MBS), or associated instruments on low
cost credit and then reselling, more were drawn into or otherwise affected by such
transactions.
Some were of course prompted by speculative profit-seeking for their own accounts.
Others were pressed into participating by clients on whose accounts they traded. 37 Still others
were pressed in effect by the speculators themselves, via the disproportionate impact the
latter’s transactions exerted on prices that even ordinary folk had to pay – and, increasingly, to
borrow to pay. 38 And as more came to transact on these terms, prices naturally rose higher, at
accelerating rates, increasing profit opportunities yet further.
In effect, a spontaneously emergent “Ponzi,” or “pyramid” process developed in the
nation’s largest primary and secondary real estate markets over the 1990s and early 2000s – a
process that, crucially, requires no actual Ponzi or schemer to commence or persist. 39 The non35

This is of course what accounts for some mortgage originators’ having sought ever more “marginal”
borrowers to whom to lend on ever more risky, “sub-prime” terms – and even non-marginal buyers to switch into
more marginal, higher risk higher return mortgage arrangements – as the pool of prospective new buyers shrank
and the bubble neared its prospective-new-entrant-determined natural limiting perimeter. It also accounts for the
uptick in fraudulent credit practices as the limits of pools of new entrants, and thus of the bubble itself, were at
long last approached. See Hockett, A Fixer-Upper for Finance, supra note 5.
36
It bears noting, moreover, that many of these speculative buyers and fraudsters whose purchases set the
prices that even cautious and honest buyers had to pay purchased multiple properties, in effect levering up their
own influence on prices. See id.
37
Much anecdotal evidence suggests that many hedge fund managers sought to pull out of or even short
real estate during the late stages of the bubble, only to be told by their clients that they would withdraw their
funding and invest elsewhere were the managers to do so. See, e.g., Hockett, Fixer-Upper, supra note 5; and
Geanakoplos, Promises, Promises, supra note 33.
38
See sources cited supra, note 33.
39
This is a core message of Hockett, Fixer-Upper, supra note 5, in which the term “spontaneously emergent
Ponzi process” is introduced. See also Hockett, Bubbles, Busts, and Blame, supra note 25; and Hockett, Recursive
Collective Action Problems, supra note 6. Blame there might have been, but it is altogether unnecessary to explain

8

necessity of any such Ponzi or schemer in these processes is important. It is precisely the sense
in which processes of this sort stem from classic coordination problems – problems that result
from, rather than defying, individual rationality, even ethically blameless such rationality.
This is not to say there was no blame or irrationality during our recent property price
bubble; there always is, bubble or no.40 It is only to say that these would have been inessential,
and in that sense didn’t lie at the core of the crisis. 41 All that was needed was underpriced
credit, which was destined to remain underpriced for as long as the aforementioned capital
surpluses built up in Asia and elsewhere over the years leading into the crisis held out or, worse
yet, continued to grow – as they did.
Hence there is no need to point fingers at anyone – home buyer, lender, or secondary
market investor – in explaining what happened. There is only a need to clear up the wreckage
that these individuals are no better positioned collectively to clear than they were to prevent.
To appreciate all of this more concretely, it is instructive before moving on to consider a
typical transaction of the era from the distinct points of view of the parties concerned.
From the lender’s or investor’s point of view, then – whether first mortgagee or second,
portfolio loan holder or MBS buyer – it made sense during the boom to make investments that
would have looked less prudent in earlier times, precisely in virtue of the steady appreciation of
collateral wrought by the bubble itself.42 Borrowers were, after all, less apt to default given the
luxuriant refinancing opportunities which that appreciation afforded. And the growing
expected values (EVs) of performing loans and underlying collateral more than offset expected
losses from incremental default rate increases in any event. 43
From the buyer’s point of view, in turn, accepting loans from the mentioned investors –
even “second” such loans, and the higher-cost nonprime, or higher-complexity adjustable rate
loans that many originators increasingly channeled them toward 44 – made sense both for
what happened over the course of our most recent bubble and bust. The idea of a “naturally occurring Ponzi
process” figures prominently in the exceedingly prescient ROBERT SHILLER, IRRATIONAL EXUBERANCE (2000), which
introduces this critically important idea.
40
See again, in particular, Hockett, Bubbles, Busts, and Blame, supra note 25.
41
Id.
42
See again Hockett, A Fixer-Upper for Finance, supra note 5; and Hockett, Recursive Collective Action
Problems, supra note 6.
43
Id.
44
For more on the lenders’ channeling even prime borrowers toward more profitable non-prime loans, see,
d
e.g., Hockett, A Fixer-Upper for Finance, supra note 5; also CHARLES MORRIS, THE TWO TRILLION DOLLAR MELTDOWN (2
ed., 2010).

9

distinct reasons and for the same reasons that extending this credit made sense to investors:
For one thing, as noted above, most buyers had little choice but to buy on the terms set by the
speculator-driven boom market itself. For another, appreciating home values made refinance
easy in any event, well before adjustable rate mortgage loan payments might adjust upward.
Indeed, the then-esteemed Fed Chairman publicly told buyers as much.45
That of course takes us to the regulators. From many of their points of view –
particularly those who were not charged with overseeing the financial or monetary systems as
integrated wholes – heightened regulatory concern looked unnecessary for counterpart
reasons to those just considered.46 Steadily rising home values meant less risk – less risk to
borrower, lender, secondary market investor, and hence general public alike from the points of
view of these non-systemic regulators. 47
Much the same calculus appears to have affected, in this case more problematically, the
thinking of that authority charged with overseeing our financial system as one systemically
integrated whole on behalf of all actors – that all-important collective monetary agent known
as the Fed 48 – though in this case there were additional, seemingly more compelling reasons to
stand back. 49
One such reason stemmed from the salutary consequences of the “wealth effect”
wrought by home price appreciation on consumer demand. These were consequences that
were bound to appeal in view of (1) U.S. growth- and employment-imperiling real wage
stagnation from the 1970s onward, combined with (2) the Fed’s maximum sustainable growth
and employment mandates. 50
Another seemingly compelling reason for Fed inaction was the fact that it likely could
not fully sterilize incoming credit in any event – at least not without either (1) backtracking on

45

See, e.g., Greenspan Says Personal Debt is Mitigated by Housing Value, N.Y. TIMES, Feb. 24, 2004, at C11.
See Hockett, A Fixer-Upper for Finance, supra note 5; Hockett, Bubbles, Busts, and Blame, supra note 25.
47
Id.
48
The critical role of the central bank or monetary authority as necessary collective agent in respect of the
financial system is a central theme of Hockett, A Fixer-Upper for Finance, supra note 5; Hockett, Bubbles, Busts and
Blame, supra note 25; and Hockett, Bretton Woods 1.0, supra note 6. See also Robert Hockett, Money, Finance,
and Collective Action, 6 J. APP. ECON. __ (2012).
49
See again Hockett, Bretton Woods 1.0, supra note 6.
50
See Alpert, Hockett, & Roubini, The Way Forward, supra note 22. The mentioned mandate is codified at
12 U.S.C. § 225(a).
46

10

global financial openness, or (2) using blunt policy instruments widely thought apt to kill
healthy transaction activity economy-wide.51
In short, then, even altogether blameless decisions taken by all concerned parties, with
the possible exception of that collective agent that is the central bank, would have been
consistent with what we have been through – and, as Section II will soon demonstrate, what we
are still going through. It was precisely most parties’ acting in financially defensible manners
that enabled the bubble to form, then expand for as long as the credit remained inexpensive
and prospective new entrants to real estate markets could be tapped.
And for as long as this process continued, in turn, even the great majority of sober, nonspeculative investors and home buyers had to transact on terms set by the bubble. Home
buyers were forced, in other words, to enter into fixed debt obligations, with ever higher
principal, simply in order to purchase and inhabit ever more expensive, speculative-marketvalued, variably priced homes. 52
Once the pool of prospective new home buyers was finally exhausted, however, and
prices in consequence peaked and then plunged, millions of home-buyers could not but now
find themselves suddenly “underwater,” hunkering down under “debt overhang” with
“negative equity.” Their variable rate assets – not to mention lender collateral – had
plummeted in value, while their fixed debt obligations had not. That left them with more in
debt obligations – often very much more – than in underlying home equity.

51

See Hockett, Bretton Woods 1.0, supra note 6. It is perhaps worth noting, if only in passing, that scholars
at the Bank for International Settlements – notably Claudio Borio and William White – have been consistently
more optimistic about the prospects of “leaning” (against the proverbial wind) as distinguished from “cleaning” (up
after a crash, the policy preferred in American circles since the end of the Martin and Volcker eras, at any rate).
See again Hockett, A Fixer-Upper for Finance, supra note 5; Hockett, Bubbles, Busts, and Blame, supra note 25; and
Hockett, Money, Finance, and Collective Action, supra note 48. A very good overview of the pro-leaning position,
with critique of the pro-clean position, is William R. White, Should Monetary Policy Lean or Clean?, working paper,
available at http://www.bnm.gov.my/files/publication/conf/hilec2009/s04_sp_white.pdf. The American
consensus appears to be shifting now a bit more toward the BIS position once favored by earlier Fed Chairmen
William McChesney Martin and Paul Volcker, but it is not there yet and could not have been further from it over
the course of the late 1990s and early 2000s. See sources just cited. The author and his FRBNY colleagues Tobias
Adrian and Meg McConnell are now working along these lines in constructing what we are calling a
“macroprudential tool kit.”
52
See, again, Hockett and Geanakoplos sources cited supra, note 33. It should be noted that by “fixed
nominal debt obligations” we mean obligations that do not change with market prices, in contrast to variable
market prices themselves. The latter’s varying upward is what opens spreads and makes borrowing to buy more
attractive; its varying downward is what leaves debt overhang that can induce debt deflation.

11

And as this left the mortgagors vulnerable, of course, so has it left mortgagees who rely
on their payments – along with everyone else whose wellbeing depends on the health of the
mortgage markets. That, as we’ll soon see, is all of us.
So this is where much of the nation, and in particular those states and municipalities
that have been since the start at the heart of the crisis, now find themselves. As of January
2012, fully $7 trillion in household home equity wealth had been lost since 2006, while nearly
one quarter – over 22% – of the 52.5 million mortgaged homes in the U.S. were underwater.53
If for the sake of illustrative case study we concentrate attention on, say, California (“the
State”) and one of its counties in particular, San Bernardino (“the County”) – both of which lay
at the epicenter of the bubble and bust – the figures are yet higher: 2 million homes,
representing 30% of the total Statewide, and 168,000 homes, representing 43 % of the total
Countywide.54 These remarkable numbers are of course but the balance sheet manifestations
of slumped and still sagging, record-low post-bubble home prices which, nearly six years after
the peak and the plunge, are down 34% from 2006 levels nationwide, 50 % Statewide, and over
50% Countywide. 55
Yet all of this, worrisome as it all is, is not all. Matters are growing yet worse.
Notwithstanding periodically transient, scattered signs of improvement in some shifting
national localities, the S&P Case Shiller 20 City Index now shows home prices down fully 9%
from their previous post-bubble high – itself low in relation to longer term trend – reached in
2010.56 The counterpart state and County figures are proportionately worse: approximately
11% for the State, and 14% for the County.57 Meanwhile, a backlog of nearly 400,000 homes
nationwide awaited liquidation at the end of 2011, with another 2.86 million mortgages twelve
or more months delinquent.58 And again the State and County figures are worse. 59

53

CoreLogic. See also Alpert, Hockett, & Roubini, The Way Forward, supra note 22. Also Michael Campbell
& Robert Hockett, White Paper in Support of the Home Mortgage Bridge Loan Assistance Act of 2012, available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1987159.
54
CoreLogic. For more on why San Bernardino makes for an illustrative case study, see, e.g., Jennifer
Medina, In California, Economic Gap of East vs. West, NEW YORK TIMES, April 14, 2012, page 1, available at
http://mobile.nytimes.com/article;jsessionid=ADA9B1FACB49BF39B4CF50B58646AFBF.w6?a=938651&f=19.
55
See www.dqnews.com for State - $484K in 2007 and $239K in Feb2012 - and www.City-Data.com for
County – approximately $380K in 2007 and $155K in 2011.
56
See Robert Hockett, Six Years On and Still Counting, supra note 3; and Campbell & Hockett, White Paper in
Support of the Home Mortgage Bridge Loan Assistance Act of 2012, supra note 53.
57
See www.dqnews.com for State - $270K in July 2010 and $239K in Feb 2012 - and www.City-Data.com –
approximately $180K in 2010 and $155K in 2011.
58
Id.
59
Figures forthcoming.

12

The upshot of these numbers is a current “shadow inventory” of some 3.25 million
homes nationwide, 174,000 homes Statewide, and 14,000 homes Countywide that are either
already foreclosed or on the brink of foreclosure. 60 These are inventories which, as they
continue to grow, weigh all the more heavily on home prices, families, neighborhoods, towns,
and the national, state, and local economies. In light of these trends, widely followed real
estate analysts estimate that between 7.4 million and 9.4 million additional home loans
nationwide now are at serious risk of default in the coming six years. That is an impending
foreclosure tsunami of apparently unprecedented proportion, rather as our recent bubble and
the global glut fueling it were either unprecedented or only once-precedented. 61 And this is
assuming no further price declines or interest rate rises.
But alas, owing to feedback effects of the sort sketched above and to be encountered
again just below, further such price declines cannot be realistically assumed away. 62
Underwater homeowners who live in the shadow of debt overhang don’t spend. That drains
growth- and employment-maintaining consumer demand from the economy. Because homes
represent by far the largest store of wealth for the great majority of middle class Americans,
moreover, 63 and because that middle class in turn represents by far the greatest source of

60

CoreLogic, September 2011.
See Testimony of Laurie S. Goodman, Amherst Securities Group, to the U.S. Senate Subcommittee on
Housing, Transportation, and Community Development, March 15, 2012, available at
http://banking.senate.gov/public/index.cfm?FuseAction=Files.View&FileStore_id=0f96e0ff-8500-41a5-a0f20139d0df2e07; and Laurie Goodman et al., The Case for Principal Reductions, 17 J. STRUC. FIN. 29 (2011). Also Gus
Lubin, “Laurie Goodman on Why Another 11 Million Mortgages Will Go Bad,” Business Insider, July 26, 2011,
available at http://articles.businessinsider.com/2011-07-26/markets/30092548_1_shadow-inventory-defaultrates-loans.
The one possible precedent, of course, is that of the global and U.S. financial and housing economies of
the late 1920s and 1930. See Hockett, A Fixer-Upper for Finance, supra not 5 for reminder that the 1920s featured
a real estate bubble in addition to a financial market bubble, the pairing of which two always seems to issue in the
longest-running post-bust debt deflations. Also Hockett, A Jeffersonian Republic Through Hamiltonian Means, 79
S. CAL. L. REV. 53 (2005). As for the uncertainty whether the prior case rivaled or surpassed the most recent in
magnitude, this owes to want of data in connection with the previous instance. See Alpert, Hockett, & Roubini,
The Way Forward, supra note 22. On debt deflations, see the same; the locus classicus, for its part, is of course
Irving Fisher, The Debt-Deflation Theory of Great Depressions, 1(4) ECONOMETRICA 337 (1933).
62
See, e.g., Alpert, Hockett, & Roubini, The Way Forward, supra note 22; Federal Reserve Board, supra note
8; Dudley, supra note 8; and Campbell & Hockett, White Paper in Support of the Home Mortgage Bridge Loan
Assistance Act of 2012, supra note 53, for further elaboration of the dynamics described in this paragraph. See
also Adrian and Shin sources cited supra, note 27, and Geanakoplos sources cited supra, note 33. Finally, see again
Fisher, as cited id.
63
This is another important motif in the work of Robert Shiller. See SHILLER, IRRATIONAL EXUBERANCE, supra
note 39. Also ROBERT SHILLER, MACRO MARKETS (1993); ROBERT SHILLER, THE NEW FINANCIAL ORDER (2003); and ROBERT
SHILLER, THE SUBPRIME SOLUTION (2008). See also the second edition of the aforementioned IRRATIONAL EXUBERANCE,
published in 2005 with addition chapters on the housing bubble. And Robert Hockett, Just Insurance Through
Global Macrohedging, 25 U. PA. J. INT’L ECON. L. 107 (2004).
61

13

American consumer demand, the drag on the larger economy is massive. Indeed it is by far the
heaviest drag on general post-crisis recovery. 64
To be sure, not all currently troubled mortgages are underwater. Some homeowners
are now facing difficulty keeping current on monthly payments simply for reasons of temporary
un- or underemployment stemming as radial effects from the broader underwater-mortgageinduced slump. For this class of mortgagor, the author of this Memorandum and a colleague at
the Fed have designed a Home Mortgage Bridge Loan Assistance Program, informed by a
successful Pennsylvania program put into place during the steel slump of the early 1980s. The
bill that would institute the program, happily, is now poised for adoption in the State of New
York. 65 But …
Critically, however, this class of troubled mortgage is nowhere near being the principal
drag upon mortgage market and more general economic recovery. That status is
overwhelmingly held by underwater mortgages, which default at accelerating rates in
proportion to their negative equity, suffer disproportionate losses on liquidation, and radiate
through the larger economy pursuant to the feedback mechanisms noted in the previous
paragraph but one. And notwithstanding this fact – that fact that they are the real proverbial
“elephant in the room” – they are likewise, ironically, the one class of troubled mortgage about
which virtually nothing has been done. This in turn stems from what turn out to be yet more
coordination challenges that we elaborate next, in Section II.
Our foreclosure crisis, then, bad enough already, is prone to continued self-worsening
just as the bubble from which it proceeds was self-augmenting. Mass foreclosures and
expected foreclosures further depress home prices, which further depress consumer
expenditures, which further depress employment and income, which further heighten the
incidence of default and foreclosure, which further depress home prices – and so on,
snowballing again.66 And all of this, of course, correspondingly lessens the real value of those
balance-sheet-overvalued assets – mortgage loans, MBS, and associated instruments – still on
64

Numbers. See sources cited supra, notes 63 and 64. For interesting anecdotal evidence as well as
citations to multiple empirical studies by University of Chicago economist Amir Sufi, see Binyamin Appelbaum,
Where Housing Once Boomed, Recovery Lags, NEW YORK TIMES, April 2, 2012, p. 1.
65
See Michael Campbell & Robert Hockett, The Home Mortgage Bridge Loan Assistance Act of 2012,
available at http://www2.nycbar.org/pdf/report/uploads/9_20072233-BridgeLoanAssistanceProgram.pdf. Also
Campbell & Hockett, White Paper in Support of the Home Mortgage Bridge Loan Assistance Act of 2012, supra note
53.
66
A few numbers prove telling: The National Association of Realtors, in its December 2011 survey, finds
that foreclosure sales on average result in a discount of 22% relative to non-distressed home sales. (That
compares to 20% as of December 2010.) Short sales, for their part, averaged 13% below market. Id. And these
are conservative estimates, inasmuch as RealtyTrac has found even larger discounts.

14

the books of the primary and secondary investors whose claims these properties secure. 67 No
one, in other words, is spared.
The interested parties, meanwhile, hang back in holding patterns or “kick” the
proverbial “can down the road,” many apparently hoping for “some miracle to happen” before
the reality of more mass foreclosure, eviction, property degradation and booked asset
devaluation, all temporarily stayed until recently by “robosigning” scandal-induced caution,
recommences.68 This waiting, itself rooted in coordination hurdles of the same sort as enabled
the bubble and bust in the first place, is what now permits the downward spiraling to continue.
Only a Plan of the form drawn up below, pursuant to which municipalities act as collective
agents for the fragmented parties, can reverse the self-worsening trend. The following Section
explains why.

II. What Has to Happen, and Why It Does Not
Home prices are not going to rise back to pre-crisis, boom-period levels. If they were, it
would not have been a bubble that we’ve just experienced. The excess-credit-fueled, artificially
overvalued housing market just was that bubble, hence is precisely what brought us the crisis
we’re living through. Against that backdrop, the only conceivable options for ending the
ongoing crisis are either (1) to restart and resume the bubble itself via some heretofore
undiscovered artifice, 69 or (2) to revalue assets and liabilities formally as the markets
67

See, e.g., Federal Reserve, supra note 8; Dudley, supra note 8; Campbell & Hockett, White Paper in
Support of the Home Mortgage Bridge Loan Assistance Act of 2012, supra note 53.
68
For reasons addressed in full further below in this Section, programs like the federal government’s Home
Affordable Mortgage Program (HAMP) and Home Affordable Refinance Program (HARP) have been notably
unsuccessful. For one thing, only 2.26 million out of 14 million troubled mortgagors have modified their
mortgages under these costly programs. For another, more troubling thing, fewer than 50% of these 2.26 million
themselves were still current at year-end 2011. The reason is clear: Neither program has successfully addressed
the underwater mortgage problem head on by bringing significant principal reductions to affected mortgages.
Most modifications have simply capitalized previously missed mortgage payments or reduced monthly payments
by less than 10%. But it is overwhelmingly underwater mortgages that default. See, e.g., Goodman, sources cited
supra, note 61; also Alpert, Hockett, & Roubini, The Way Forward, supra note 22; and Chris Foote et al, Negative
Equity and Foreclosure, Federal Reserve Bank of Boston Federal Government Policy Discussion Papers 08-3 (2008),
available at http://www.bos.frb.org/economic/ppdp/2008/ppdp0803.pdf.
No plan of action that does not make significant use of principal modification so as to bring earlier,
bubble-priced debt into line with current, post-bubble collateral value will do anything more than put off the
inevitable day of re-reckoning, and in so doing worsen the losses and harms mentioned above and catalogued
more fully below. See Alpert, Hockett, & Roubini, The Way Forward, supra note 1. Also Federal Reserve, supra
note 8; Dudley, supra note 8; Campbell & Hockett, White Paper in Support of the Home Mortgage Bridge Loan
Assistance Act of 2012, supra note 53.
69
Some have proposed the artifice of more central bank purchases of MBS, others – for example, Ken
Rogoff and, more recently, Paul Krugman – the artifice of targeted higher consumer price inflation. See, e.g.,

15

themselves have begun doing realistically. 70 Reflate the bubble, in other words, bringing
variable rate assets back into line with the fixed debt obligations that financed their purchase,
or trim back the debt obligations themselves: write down principal.
Since option (1), for its part, is at best only conceivable, not really practicable or
desirable, 71 option (2) is the only realistic and desirable possibility. Debt must be trimmed back
to eliminate negative equity, else the time-honored correlation between high LTV and default
find expression in more rounds of foreclosure. It isn’t a question of whether, but when – and
how. We can act to ensure that the overhung debt’s written off in an orderly, expeditious, well
managed manner that is equitable, efficient, and value-preserving for all. Or we can continue
to sit back and watch things unfold in a manner that proves chaotic, uncertainty-fraught,
inequitable and colossally wasteful.72
All parties recognize this. So do commentators across a broad spectrum running from
Reagan Administration economist Martin Feldstein to grassroots progressivist outfits like
MoveOn.org, and from top mortgage insurer Radian Group to top bond fund PIMCO. What
then prevents interested parties’ writing down principal accordingly? What blocks their acting
in their own best interests?

Kenneth Rogoff, The Bullets Yet to Be Fired to Stop the Crisis, FINANCIAL TIMES, August 8, 2011, available at
http://www.ft.com/intl/cms/s/0/1e0f0efe-c1a9-11e0-acb3-00144feabdc0.html#axzz1s3nCG5bY; Paul Krugman,
Not Enough Inflation, NEW YORK TIMES, April 5, 2012, available at
http://www.nytimes.com/2012/04/06/opinion/krugman-not-enough-inflation.html?_r=1.
These would amount to mere partial reflation of the bubble, but are nevertheless suboptimal for reasons
elaborated in Alpert, Hockett, & Roubini, The Way Forward supra note 22. One reason is that the proverbial
inflation “genie” is difficult to get back into the “bottle” once out. The other is that inflation tends
disproportionately to harm old-age pensioners and those with lower incomes, at least unless and until we are
prepared to countenance central bank targeting of more asset classes in open market operations, per Robert
Hockett, How To Make QE More Helpful: By Fed Shorting of Commodities, BENZINGA FINANCE, October 14, 2011,
available at http://www.benzinga.com/news/11/10/1988109/how-to-make-qe-more-helpful-by-fed-shorting-ofcommodities#.
70
See Alpert, Hockett, & Roubini, The Way Forward, supra note 22; Goodman Testimony, supra note 61.
Also Campbell & Hockett, White Paper in Support of the Home Mortgage Bridge Loan Assistance Act of 2012, supra
note 53.
71
See supra, note 69.
72
It should be noted that, in view of the losses entailed by default and foreclosure themselves, markets
value foreclosure-prone properties and associated MBS at rates even lower than marked-down and accordingly
no-longer foreclosure-prone properties and associated MBS. Hence the Municipal Plan, the details of which are
laid out in Section III of this Memorandum, should restore home, mortgage, and MBS values to pre-crisis levels,
just not bubble-era levels. For more on the way in which the same recursive collective action problem as results in
artificially overvalued assets during a bubble results in artificially undervalued assets during a bust, see Robert
Hockett, Bailouts, Buy-Ins, and Ballyhoo, 52 CHALLENGE 36 (2009); also Hockett, A Fixer-Upper for Finance, supra
note 5; and Hockett, Recursive Collective Action Problems, supra note 6.

16

In light of what has been noted above about coordination problems, it will be
recognized at once that this is not unlike asking what prevents all parties from exiting safely
from a burning theatre. Actions that would be taken by multiple parties in situations like that in
which we now find ourselves, if they would not be self-defeating, must be orchestrated. They
inherently pose collective action challenges that properly authorized collective agents – in
effect, orchestral conductors – must address on behalf of the many diffuse parties concerned.
In this sense, the present revaluation impasse – the challenge to plenary principal
writedowns – just is the flipside of the precedent bubble itself. 73 Much as it was individually
rational and indeed unavoidable, absent forceful Fed regulation of leverage conditions, for
individual market actors to enter into transactions that ultimately aggregated into the bubble,
and just as it is individually rational, absent direction, for each theatergoer to press toward the
exit on learning of fire, so is it rational for each creditor post-bubble, absent combined
orchestration, to await others’ revaluing first.
Why? There are several reasons to catalogue, but the most “deep-structural” one is
that the last to revalue in such circumstances ultimately faces least need to revalue. Everyone
else’s revaluing eliminates debt overhang, thereby lowers aggregate default risk, and so raises
property prices. That in turn lessens the degree to which any last mortgage remains
underwater – indeed it will probably lift it above water. Every mortgagee therefore has reason
to wish to be last, rather as each fleeing theatre-goer has reason to wish to be first. 74 All
accordingly wait for the others to act, in effect reenacting the Vaudeville routine in which two
parties first try to crowd through one door, then step back, each saying, “after you.” Under
such circumstances, no one gets anywhere. 75
This is of course problem enough, structural as it is. And yet it is but one of the full
cluster of collective action problems we face where would-be plenary principal write-down is
concerned. For there are many additional impediments, most rooted in contractual practices
begun during the boom years which few thought would end, to privately ordered loan
modification in contemporary mortgage markets. It will be helpful here briskly to catalogue the

73

See again Hockett, Bailouts, Buy-Ins, and Ballyhoo, id.; and Hockett, Recursive Collective Action Problems,
supra note 6.
74
The symmetry here is no accident. Note that bubble participants also have reason to wish to be first – as
do runners on banks and on assets in busts.
75
The shtick is often associated with the French cartoon characters Alphonse and Gaston. See, e.g., this
portrayal: http://en.wikipedia.org/wiki/Alphonse_and_Gaston. (Thanks to Bob Shiller for finding and sending the
image.) The situation is also reminiscent of that posed by the apocryphal Kansas statute reported in Prosser’s
canonical casebook on the law of tort: The statute purportedly required, of any two trains nearing each other
from opposed directions, that each train stop and await the other one’s passage.

17

most formidable of these. Doing so renders all the more clear why the Plan sketched below is
so urgently necessary.
The first additional impediment to plenary mortgage loan modification, then, stems
from the securitization arrangements pursuant to which most contemporary mortgage loans
are now held – arrangements which, we shall see, are accordingly the first targets of the Plan
we propose below. The fragmentation of ownership interests both in pools of mortgage loans
and, thereby, even the individual mortgage loans themselves, renders it impossible for creditors
to act in concert to modify underlying loans. 76 There is no way for these hundreds of thousands
of people even to find one another, let alone act together. In effect, mortgage loan pooling
puts the traditional creditor coordination problem, endemic to all situations involving multiple
creditors, “on steroids,” if one may speak in the current vernacular.
The problem is rendered yet worse by pool tranching structures that can place some
pool participants – for example, senior and junior tranches – at odds with each other where the
timing of modification is concerned: the so-called “tranch warfare” problem. 77 And this is not
even to mention the fact that each pool holds multiple loans, each distinct one of which would
have to be dealt with, in the event of impending insolvency, by the fragmented and
fragmented-interest-holding creditors. 78
The second additional impediment to plenary loan modification likewise stems from the
securitization arrangements that proliferated during, and indeed helped to fuel, the real estate
bubble. Because securitized creditors are too dispersed to act in concert, as just noted, the
pooling and servicing agreements (PSAs) pursuant to which mortgage loans are aggregated vest
authority to collect loan payments in a single collective agent – the servicer, typically a banking
institution. But the same PSAs’ terms often flatly prohibit, or otherwise strictly limit – for
example, through supermajority consent requirements – servicers from modifying pooled
loans. 79 They also prohibit or limit their selling such loans.80 So the one party explicitly vested
76

In theory, of course, indenture trustees and servicers are charged with the task of acting on behalf of the
dispersed creditors; but as will become apparent below, the PSAs pursuant to which securitization trusts are
formed typically limit these agents’ capacities to do what needs doing right now. See infra, next several
paragraphs. See generally Hockett, Six Years On and Still Counting, supra note 3.
77
Id.
78
Id.
79
Id. See also Office of the Comptroller of the Currency, Office of Thrift Supervision, Mortgage Metric
Report for Third Quarter 2008 (2009); Office of the Comptroller of the Currency, Office of Thrift Supervision,
Mortgage Metric Report for Fourth Quarter 2008 (2009); Office of the Comptroller of the Currency, Office of Thrift
Supervision, Mortgage Metrics Report for First Quarter 2009 (2009). These and additional reports are available at
http://www.occ.treas.gov/publications/publications-by-type/other-publications-reports/index-mortgagemetrics.html. See also Tomasz Piskorski et al, Securitization and Distressed Loan Negotiation: Evidence from the
Subprime Mortgage Crisis (2010), Chicago Booth School of Business Research Paper, No. 09-02, available at

18

with collective agency to act on behalf of our fragmented creditors and their financial wellbeing
is contractually impeded from taking the one action that is most needful right now for the
creditors themselves – expected value (EV) maximizing principal reduction.
A distinct but related obstacle here is that PSAs also determine the compensation
arrangements pursuant to which servicers are paid. And these arrangements, made during the
boom years with no evident thought that a property price bubble, bust, or consequent default
and foreclosure tsunami might occur, overwhelmingly place servicer compensation incentives
at variance with lenders’ and borrowers’ value-preserving loan modification interests. 81
In the vicinity of borrower insolvency, RMBS servicer fees generally are independent of
borrower payments. The upshot is that servicers often fare better financially over a 12 to 18
month period of borrower default than over any comparable period of debt renegotiation,
restructuring, and payment resumption. Meanwhile, (1) the aforementioned fragmentation of
securitized residential mortgage investors, and (2) counterpart dispersion, accompanied by
missing information, demoralization, and weak bargaining power on the part of borrowers,
conspire to impede any spontaneous development of more incentive-aligning servicer
compensation arrangements.82

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1321646; John P. Hunt, What Do Subprime Securitization
Contracts Actually Say About Loan Modification? Preliminary Results and Implications, March 25, 2009, working
paper, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1369286; and Credit Suisse, The Day After
Tomorrow: Payment Shocks and Loan Modifications (2007).
80
Id. Hence, incidentally, one of the attractions of legally mandated sale – compensated taking under
eminent domain authority – as proposed infra, Section III.
81
See, e.g., sources cited supra, note 79. See also Larry Cordell et al, The Incentives of Mortgage Servicers:
Myths and Realities, Finance and Economics Discussion Series, Divisions of Research & Statistics and Monetary
Affairs, Federal Reserve Board, Washington, D.C., No. 2008-46 (2008), available at
http://www.federalreserve.gov/pubs/feds/2008/200846/revision/200846pap.pdf; and Sarah Bloom Raskin,
“Putting the Low Road Behind Us, Remarks at the Midwinter Housing Finance Conference,” Park City, Utah,
February 11, 2011, available at
http://www.google.com/imgres?imgurl=http://www.federalreserve.gov/aboutthefed/bios/board/bloom_raskin_s
arah_web.jpg&imgrefurl=http://www.federalreserve.gov/aboutthefed/bios/board/raskin.htm&h=201&w=176&sz
=57&tbnid=sicY7NccRVY5gM:&tbnh=104&tbnw=91&prev=/search%3Fq%3DSarah%2BBloom%2BRaskin%26tbm%3
Disch%26tbo%3Du&zoom=1&q=Sarah+Bloom+Raskin&hl=en&usg=__Jt7XFwpo3QK80uc0jC3_8dHDcP0=&sa=X&ei
=70QfTtbPFsnb0QGInpS1Aw&ved=0CDUQ9QEwAw.
82
See sources cited id., as well as Hockett, Six Years On and Still Counting, supra note 3. It is interesting to
note, by way of contrast, that in the securitized commercial real estate mortgage market the sizes of individual
loans in the pools appear to have rendered lenders and borrowers more active in negotiating more incentivealigning servicer compensation arrangements. Here securitized commercial loan servicers divide into two
specialties – transaction processors and loss mitigators, with delinquent loan payments triggering shifts in
responsibility from the former to the latter. The latter, in turn, are paid in proportion to restructured loan
performance, rather than in the form of fees that are independent of such performance. See again Hockett, Six
Years On and Still Counting, supra note 3.

19

Another distinct but related point is that the residential real estate loan servicing
industry, whose personnel, practices, and technologies also were retained during times when
the prospect of system-wide bust and foreclosure were not contemplated, has simply been
overwhelmed by the sheer magnitude of the bust. Neither the numbers and specializations of
personnel, nor the technologies by which documents are maintained and retrieved, have been
equipped to respond to the scale of the problem we’re now living with.
This is so whether the scale in question be measured in numbers of loans, amounts
owed on loans, or numbers of heterogeneous PSAs carrying distinct sets of terms and
requirements with which servicers must comply. It is ultimately this circumstance that
accounts both the aforementioned “robosigning” scandals of two years ago, and the
recommendation of “sub-servicer” arrangements for still troubled loans in the recently
proposed settlement between Bank of America and a number of institutional investors.83
The third additional impediment to plenary loan modification stems from a surprising
turn taken by the familiar divergence of interest between first and second lienholders on
mortgage loans. It turns out that seconds possess significant “holdup” power over would-be
value-preserving modification arrangements between borrowers and firsts, notwithstanding
their subordinate status to those firsts. This power operates through another power that
seconds in turn hold over borrowers.
In essence, the problem emerges from two conjoined facts.84 The first is that firsts –
even when able to act in concert, or when not having to do so because holding single portfolio
loans – do not benefit by loan modification unless seconds modify too. This is simply a
consequence of the familiar observation, sometimes made in connection with “tranch warfare”
situations of the sort mentioned above, that creditors in the “first loss” position likewise are
first to benefit by principal reduction. The second operative fact is that seconds reap greater
benefit by not agreeing to modifications, thanks to a power they hold over distressed
mortgagors in virtue of the latter’s liquidity needs when financially strapped. 85
A squeezed borrower who cannot afford to make all payments required of her in a given
month, and who must accordingly fall behind on something, will typically fall behind first on her
83

See, e.g., Goodman, supra note 61, for more on the bust’s overwhelming of servicers. Also Hockett, Six
Years on and Still Counting, supra note 3. Note, in addition in this connection, the contrast with servicing
arrangements in the commercial real estate mortgage markets, as described supra, note 82. The Bank of America
settlement is available at http://www.cwrmbssettlement.com/docs/Exh%20B.pdf.
84
See Alpert, Hockett, & Roubini, The Way Forward, supra note 22. Also Hockett, Six Years On and Still
Counting, supra note 3.
85
See source cited supra, note 83.

20

first rather than her second mortgage loan. The reason is that default on the latter – typically a
home equity line of credit (HELOC) – means loss of capacity to pay for anything else, including
the things she must purchase to live and to work while endeavoring to dig herself out of debt.
Default on the former, by contrast, triggers a lengthy foreclosure process that affords
“breathing room” in which to attempt to put life back in order.86 Hence seconds have both
holdup power and incentive to exercise it, while firsts and their borrowers are unable to benefit
by the modification that both need and want until seconds stop wielding that power.
What is legally perverse here, of course, is that second lienholders in effect can use
power they hold over mortgagors to seize priority status from prior mortgagees – first
lienholders. In so doing they can prevent value-preserving loan modifications even by portfolio
lenders who are not faced with the extra coordination challenges, described just above, that
RMBS investors face.
Since some $873 billion in second lien term mortgages and HELOC mortgage loans, most
of them seconds, weigh on a large portion of the most deeply underwater first mortgage loans
nationwide, this impediment is particularly costly. 87 In our sample representative County,
moreover, this problem, like most of the state’s and the nation’s mortgage-related problems, is
proportionally worse. HELOCs in San Bernardino amount to significant portion of mortgage
debt. 88
But there is more here. Ironically, the servicer incentive problem mentioned a moment
ago dovetails with the HELOC holdup problem. Why? Because in many cases the servicer itself
is the HELOC second lien holder! 89 There is accordingly a conflict of interest to buttress the
aforementioned PSA, compensation, and “overwhelmedness” impediments to servicers’
agreeing to loan sales or principal reductions. Against this backdrop, the lack of plenary
principal reductions of the sort that would end our ongoing and still self-worsening mortgage
crisis could hardly be less surprising.
But wait, one might now interject, what about the federal Home Affordable Mortgage
Program (HAMP) and the Home Affordable Refinance Program (HARP)? And how about the
loans held by the government sponsored entities (GSEs) Fannie Mae and Freddie Mac – and the
MBS held by the Federal Reserve System through, for example, the New York Fed’s Maiden
Lane funds? Are these not significant sites of potentially helpful federal intervention through
86
87
88
89

See source cited supra, note 83.
See Alpert, Hockett, & Roubini, The Way Forward, supra note 22.
Figures to come.
See Goodman, sources cited supra, note 61.

21

which principal might be widely writ-down? Can the federal government not act, by dint of its
multiple concentrated ownership stakes, as that collective agent which is evidently required to
solve that thus far intractable collective action problem which is our ongoing and still selfworsening mortgage crisis?
Alas, it seems not – at least not to the requisite degree. The reasons are once again
many. The most tenacious is probably the ideologically divided U.S. Congress, 90 combined with
the fact that the first costs and immediate urgency of our nation’s self-worsening mortgage
crisis are experienced more directly by the localities in which mortgaged property is located
than by the more remotely located federal government. 91 These facts alone render the federal
government unlikely to purchase possession of mortgage loans outright with a view to
restructuring or refinancing them, or even to refinance those they already hold. But there is yet
more to the story.
It is true that some federal instrumentalities already possess large pools of mortgage
loans or associated securities in such manner as might help enable restructuring. The
aforementioned Fed funds of course hold some. But these represent only a fraction of all such
outstanding and have in any event been held from the start with a view not to holding them
indefinitely, but instead for the short term until markets recover. The purpose from the outset
has been to address liquidity crises faced by a number of large financial intermediaries whose
balance sheets were widely believed to hold unsustainable quantities of “toxic” assets in 2008.
That limited purpose in turn limited the kind and quantity of assets purchased, and of course
also is why the Fed now is selling them off at a profit.
Fannie and Freddie could have been – and still might turn out be – a somewhat different
story. The GSEs do hold significant numbers of loans for which they could in theory write down
principal. The principal holdups in this case appear to be three, two of them apparently rooted
in one source. The first is that Fannie and Freddie themselves use thousands of distinct
servicers to service the loans that they hold, meaning that the “overwhelmed servicer”
90

One might partly pun here by saying that there is yet another “collective action problem” in this case,
since the deeply divided Congress is simultaneously (a) evenly divided and (b) operating in its Senate subject to
supermajority voting requirements – the classic recipe for “gridlock.”
91
“First” costs, “immediate” urgency, and “more directly” because the first costs are the foreclosures,
attendant evictions, property value and attendant revenue base declines, and like harms elaborated more fully
infra, Sections III and V, which affected localities experience unmediated – a fact which will figure into the
justification of recourse to municipal eminent domain infra. Later costs experienced by the nation at large are
“mediated” and “less direct” because they involve radial effects of mortgage debt overhang and foreclosure on
consumer spending, growth, and employment in the macroeconomy – costs which some members of Congress
evidently do not realize stem more from the ongoing mortgage crisis than, say, from women’s use of
contraceptives or the President’s birth certificate.

22

impediment mentioned above could prove operative here too. But this is the least serious of
the GSE holdups.
The second holdup is that many underwater GSE loans – somewhere on the order of
50% – are subject also to second liens, meaning that Fannie and Freddie also face the HELOC
obstacle noted above. Were they or their regulator and, for the time being, conservator – the
Federal Housing Finance Authority (FHFA) – to “play hardball” with the second lien holders,
principal write downs might be somewhat more common. But the current acting director of
the agency seems, for the time being at least, to be rather reluctant to “strong arm” the
banking institutions that hold these second liens. 92

92

There are some very tentative signs that this could change, in light of the present acting director’s recent
remarks made at the Brookings Institution and his January letter to Congressman Cummings cited immediately
below, to the effect that FHFA is assessing the prospect of principal reduction. Were such change to occur, Fannie
and Freddie could possibly prove to be helpful federal complements to the municipalities on whose behalves I am
here arguing by doing with the loans that they hold something like what Section III prescribes that the
municipalities do with the loans they purchase through condemnation from private label securitization trusts.
More on this infra. It also bears noting here that Professor Jackson’s proposal, supra note 11, and the author’s
2008 proposal noted in the same place, would have amounted to means very similar to these for achieving much
the same end. Insofar as the current acting director of FHFA changes his mode of thinking here, then, he will be
moving in the 2008 Jackson and Hockett directions.
It is also important to note, however, that the prospective principal reductions now being assessed by
FHFA would operate in tandem with HAMP, meaning that they would require significant “incentive” payments by
Treasury. That means both (1) that current FHFA thinking on principal reduction, were it to issue in actual such
reduction, would also entail significant expense to the public fisc, and (2) that the EV calculation by reference to
which the decision is to be made is stacked against FHFA approval of principal reduction. In fact, in FHFA’s current
calculations, as registered at pp. 18-19 of the Brookings address cited immediately below, HAMP-required servicer
incentive payments made by Treasury ($3.9 billion) would be more than double the EV gain enjoyed by Fannie and
Freddie ($1.7 billion). All of this, if accurate, suggests both that the publicly cost-less Plan outlined below in
Section III is both (1) just about infinitely more dollarwise efficient than HAMP-hampered principal reduction as
currently contemplated by FHFA, and (2) infinitely more likely to occur as well.
For the Brookings remarks, see Edward DeMarco, Addressing the Weak Housing Market: Is Principal
Reduction the Answer?, Remarks Delivered at the Brookings Institution, April 10, 2012, available at
http://www.brookings.edu/events/2012/0410_housing_demarco.aspx. For the mentioned letter, see Letter from
Edward DeMarco, Acting Director of the Federal Housing Finance Agency to Congressman Elijah Cummings,
Ranking Member, Committee on Oversight and Government Reform, January 20, 2012, available at
http://www.google.com/url?sa=t&rct=j&q=fhfa%20letter%20to%20cummings&source=web&cd=2&ved=0CDIQFjA
B&url=http%3A%2F%2Fwww.fhfa.gov%2Fwebfiles%2F23056%2FPrincipalForgivenessltr12312.pdf&ei=xap_T8TCGJ
Ph0wH7_rT4Bw&usg=AFQjCNF958kOhlVkOCBFW3rKmicBnBvd1g.
Note finally that Alpert, Hockett, & Roubini, The Way Forward, supra note 22, and Laurie Goodman,
sources cited supra note 61, offer helpful means of avoiding any risk of principal-reduction-induced moral hazard
of the sort with which FHFA might be concerned. (See, e.g., concerns noted at page 19 of the Brookings Remarks.)
The Federal Reserve and FRBNY President Bill Dudley, supra note 8, also endorse such readily available means of
hazard mitigation. Finally, see also HUD Secretary Donovan’s recent interventions on this subject, e.g., Housing
Secretary Pushes Mortgage Write-Downs, REUTERS, April 6, 2012, available at
http://www.reuters.com/article/2012/04/06/us-usa-housing-idUSBRE8350MS20120406.

23

The third reason that Fannie and Freddie do not, at least yet, engage in significant
principal write downs likewise takes root in the present way of thinking of the current acting
director of FHFA. The thinking in this case is apparently that, because FHFA as public
conservator of the GSEs must safeguard their assets to safeguard the fisc, writing down
principal on GSE-held loans would compromise its statutory duty.
This is of course sound thinking only if writing down principal on underwater loans
either lowers the EVs of the loans, or entails costs that exceed EV benefits. If, by contrast,
writing down principal significantly lowers default risk – which it does – and thereby increases
EVs by more than what ever administrative or other costs would be entailed by the write
downs, the long term fisc-preservation mission is actually better effected by writing down
principal. That opens an interesting door.
It should be noted at this juncture that the likelihood of principal write downs’
increasing the EVs of particular loans increases with the aggregate number of written down
loans – a compositional corollary of the first, “deep structural” collective action impediment to
privately managed principal write downs noted above. 93 But this means that the acting FHFA
director’s present way of thinking is more sound insofar as the GSEs and any entities that might
coordinate with them collectively hold fewer loans, and less sound insofar as the GSEs and any
entities that might coordinate with them collectively hold more loans. Such coordinating
entities might include, of course, municipalities.
The current acting director’s recent acknowledgement that principal write downs at
least might ultimately prove to be in the public’s interest, as noted above in note 92, is
accordingly very welcome. For it signals that municipalities’ efforts pursuant to the Plan we
elaborate below in Section III might ultimately be enhanced by diminished GSE passivity. The
GSEs’ coordinating with municipalities, or even conveying their underwater mortgages to them
for fair market value, would effectively magnify the degree of collective agency exercisable by
government instrumentalities in modifying underwater mortgage loans. That would in turn
maximize system-wide EVs and minimize, if not indeed eliminate, cost to the fisc.
It will be helpful, then, as suggested above in introducing this Memorandum and as we
shall see more fully verified presently, to think of the GSEs as potential complements to state
93

As noted above, the last to write down principal has least reason to write down principal owing to the
appreciation of home prices in response to the lessened default risk system-wide wrought by others’ principal
write downs. This is a compositional – “whole greater than the sum of its parts” – phenomenon, more extreme
versions of which are those market-wide aggregate overvaluations known as bubbles and market-wide aggregate
undervaluations known as busts. See again Hockett, A Fixer-Upper for Finance, supra note 5; Hockett, Recursive
Collective Action Problems; supra note 6; and Hockett, Bailouts, Buy-Ins, and Ballyhoo, supra note 72.

24

municipalities in solving that ongoing collective action problem which is the self-worsening
mortgage crisis. For when the municipalities begin temporarily purchasing mortgage loans and
writing down principal per the Municipal Plan elaborated below, total public holdings of
underwater mortgage loans will be all the greater.
The acting FHFA director will then have little remaining reason to suppose that the GSEs’
joining in to write down principal will have any but salutary effects on the fisc. Indeed he might
wish to convey GSE-held loans to the municipalities themselves as suggested above, in view of
the Municipal Plan’s avoidance of any public expenditure – a feature that even GSE writedowns
under the current regime would not have in operating in tandem with HAMP, to which we turn
next.
How about HAMP and HARP, then? Are they not programs that involve collective
agency at the federal level, such as can solve those collective action challenges that underwrite
our ongoing and self-worsening mortgage market slump? Alas, not really. Here we are back to
impediments that sound less in deep-structural challenge to collective action and more in
contractual and political such challenges, along with certain programmatic limitations.
To begin with HARP, here the principal problem takes the form of programmatic
limitation. HARP simply is not there for principal reduction. It’s an interest-reduction program
for GSE-held loans. That can be helpful, of course, just as can bridge loan assistance of the sort
mentioned earlier. But it is not designed to address the core problem – which is, again, the
urgent need of principal reduction.
HAMP for its part encourages some principal modification and, more so, less ambitious
forms of loan modification. This it does pursuant to the so-called “waterfall” sequencing, which
relies first on interest reduction, then on term extension, then on principal forbearance, and as
a last resort on principal forgiveness. HAMP has, moreover, even come increasingly to
contemplate principal reduction since 2010 – through the then-introduced Principal Reduction
Alternative (PRA) for which Treasury recently has announced an intention to triple incentive
payments made to creditors who opt for it.
The problem, however, is that because HAMP does not involve any collective agent’s
actually taking possession of loans, it continues to be hampered, if one might be pardoned a
pun, by the last several impediments listed above. It also occasions costs to the fisc that are
not only regrettable in themselves if avoidable, but also problematic for purposes of GSEsought principal reduction. Again, in other words, we see interlocking and mutual reinforcing
among the many impediments we must catalogue. We sketch the problems in turn.
25

First, then, HAMP cannot bring fragmented parties in interest together any more than
those parties themselves can find one another and surmount their conflicts of interest. Second,
it cannot readily undo PSA unanimity or supermajority requirements where those are present.
Third, it cannot readily undo contractual limitations on servicers’ writing down principal or
selling off loans. And fourth, it cannot seem to handle the second lien problem, particularly in
view of the favorable treatment that HAMP’s Second Lien Modification Program (2MP) affords
seconds at the effective expense of firsts. In these senses, HAMP suffers all the impediments to
parties’ themselves writing down principal catalogued above.
What can HAMP do well, then? All it can do well is to address one of the servicer
incentive problems noted above. That is helpful, of course, only for loans that do not suffer the
aforementioned contractual prohibitions. Moreover, and more damning, the only method that
HAMP has to address the servicer incentive problem is to bribe the servicers. This it does in the
form of payments of the PRA sort noted above.
In other words, HAMP works, when it works at all, through means that involve
significant public expenditure – which, again as we shall see below, the Plan we propose here
does not. And this will remain the case even should GSEs begin writing down principal in
conjunction with HAMP as noted above and in note 92. That might afford yet more reason for
GSEs themselves to go the route of the Plan we propose here in Section III, by conveying their
underwater loans to municipalities for fair market value, and perhaps even participating in the
financing of these acquisitions, like PLSTs and investors themselves as described below.
None of this is to denigrate HAMP or HARP, which have enjoyed notable successes and
even have marginally increased the rate at which they are managing to secure principal
reductions on troubled loans in the case of HAMP, and marginal foreclosure prevention through
refinance in the case of HARP. It is only to say that these programs are unnecessarily costly and
inherently limited by the baroque methodologies they employ or programmatic restrictions to
which they are subject where addressing the underwater mortgage crisis is concerned.
They can help significantly – albeit at taxpayer expense – with mortgages that are not
underwater. And HAMP for its part can even induce principal reductions – at yet heftier
taxpayer expense – in those relatively few cases where PSAs and servicer conflicts do not stand
in the way. But in these capacities they are at best marginal complements to a bona fide
principal-focused strategy. We shall see shortly that only municipalities are well situated to
embark on that strategy.

26

These, then, are the principal impediments that have stood in the way, and still stand in
the way, of senior and junior first lien holders, second lien holders, borrowers and even
servicers who might otherwise have acted in concert by now to modify mortgage loans so as to
render them payable, eliminate debt overhang, and maximize salvageable post-bubble
mortgage and collateral value for all. There have, to be sure, been additional potential
impediments. These include provisions promulgated under the Internal Revenue Code (I.R.C.)
until 2009,94 accounting standards promulgated by the Financial Accounting Standards Board
(FASB) as of 2008,95 and possibly the Trust Indenture Act (TIA) of 1939, although the latter has
not been litigated.96 But because all of these would have served solely as “fallback”
94

Sections 860A through 860G of the IRC, as interpreted by the Internal Revenue Service (IRS) under its
Revenue Procedures and Treasury Regulations at least until September 2009, conditioned the pass-through tax
treatment of those Real Estate Mortgage Investment Conduits (REMICs) that hold securitized mortgages upon
strict passivity. Modifications of underlying mortgage loans, for their part, were treated until recently as
departures from the required passivity. Hence securitized mortgage obligations up to that point could be modified
only on pain of significant back-tax penalty. Changes made by the IRS to the text of its Revenue Procedures (see
Rev. Proc. 2009-45) and Treasury Regulations (see Section 1.860G-2) in mid-September of 2009, however, which
apply retroactively to early 2008, have arguably removed this erstwhile impediment to loan modification. That
was the intention, at any rate. See Hockett, Six Years On and Still Counting, supra note 3. In the absence of any
real capacity on the part of MBS holders actually to find one another and work together with mortgagors to modify
underlying loans, however, this salutary change to the tax rules is for present purposes unhelpful. See Hockett, Six
Years On and Still Counting, supra note 3.
95
For a loan originator, who typically continues on as a servicer, to realize a gain on the sale of a loan to a
REMIC trust and remove the loan form its balance sheet as it aims to do, the trust to which it sells the loan must be
“qualified” under the accounting standards as promulgated by the Financial Accounting Standards Board (FASB)
and employed by the SEC in its regulatory roles. This in turn legally requires that the originator retain no “control”
over the assets. See Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,
Statement of Fin. Accounting Standards No. 140, Paras. 8-13 (Financial Accounting Standard Board 2008).
Although (a) the standards do not elaborate on what counts as “control,” and (b) some SEC staff have
opined that modifications of imminently defaulting loans probably would not count as “control” of the sort that
would shift assets back to originator/servicer balance sheets (see Letter from Christopher Cox, SEC Chairman, to
Rep. Barney Frank, Chairman of Comm. on Fin. Servs., US House of Representatives (July 24, 2007)), there is
sufficient uncertainty on the matter as to render the avoidance of modification prudent in the eyes of cautious
originator/servicers. As in the case of the tax provisions discussed supra, note 94, however, it is not clear that this
source of uncertainty is decisive, given the already formidable task would-be loan modifying principals would face
in attempting to find one another and then act in concert with mortgagors to restructure underlying loans. See
again Hockett, Six Years On and Still Counting, supra note 3.
96
Though the question does not appear ever to have been litigated, the terms of the Trust Indenture Act of
1939, 15 U.S.C. Sec. 77aaa-77bbb (TIA), which apply to all corporate bonds including residential mortgage backed
securities (RMBS), would seem to require unanimous consent among bondholders before rights to receive
principal and interest payments on the securities could be altered. That in turn could be expected to operate as an
impediment to modifying the terms of underlying mortgage loans – assuming, as seems plausible enough, that
such alterations would result in alterations to payments into the legal entity on whose behalf the servicer collects
on underlying mortgages before distributing proceeds to RMBS holders.
This would be so even were modifications to underlying loans demonstrably to improve expected value.
For the TIA’s requirements are categorical, while actually securing the categorically required express unanimity
among thousands or millions of RMBS holders worldwide is so highly improbable as to amount to impossibility.
While it is not clear to what extent, if any, the TIA currently figures into the thinking of servicers and trust

27

impediments behind the more fundamental and more direct obstacles to joint coordination just
catalogued,97 any plan that might substitute for interested party coordination will effectively
sidestep all impediments to loan modification and revaluation. That is precisely what the
Municipal Plan does.

III. The Municipal Plan – Structure and Operational Details
We now turn to the main event – the combined condemnation, compensation, and
mortgage loan modification Plan best able to end the still dragging, self-worsening mortgage
foreclosure crisis laid out and structurally characterized above. This Section lays out the Plan’s
fundamental attributes and financial features. The following Section lays out its legal contours
and constitutional underpinnings.
The Municipal Plan is designed specifically to sidestep all of the unnecessary
impediments that presently block meaningful debt revaluation and attendant value
maximization. It does so by forthrightly recognizing the challenge for what it is, then addressing
it accordingly.
The challenge, again, is effectively an enormous coordination problem faced by literally
hundreds of thousands, if not indeed millions, of dispersed interested parties. Each of these
parties acting individually has good reason to wait for the others to act, and so the group as a
whole fails to act. Further, even such parties as might nevertheless wish to act would be unable
to find one another to act. Contract rigidities and incentives that trustees, servicers and second
lien holders face drive the final nails in the coffin.
There is no one as yet who has proved willing and able to act in a manner that benefits
all of these fragmented parties in interest. No federal programs or instrumentalities are
properly equipped, let alone carefully aimed at the core problem.
Enter the one instrumentality that has not been considered. We refer to the states and
their municipalities – townships, cities, counties, and kindred units of local government. By
administrators intrigued by the prospect of value-salvaging mortgage modifications, given the many more
conspicuous factors already cited that serve to dissuade modification, it surely could present an obstacle were
those other obstacles to be removed. See Hockett, Six Years On and Still Counting, supra note 3. This of course
affords yet more reason to act pursuant to the Plan elaborated next, in Section III of this Memorandum.
97
See Hockett, Six Years On and Still Counting, supra note 3, for a complete catalogue of all impediments, as
well as “flowchart”-form tracing of their multiple mutual interactions. Also Alpert, Hockett, & Roubini, The Way
Forward, supra note 22.

28

acting in the name of its residents, their safety and wellbeing, and its own economic necessity –
as well as in a manner that collaterally benefits all dispersed creditors who would rather be paid
than foreclose – the American municipality is ideally positioned to solve that still worsening,
value-destructive coordination problem we face in our mortgage markets. For the problem
itself is essentially, in its first instance, local in character.
It is a real estate crisis we are living with. And it has been all along. That means it is a
local crisis before it’s a national one. Main Street’s woes are the ultimate source both of Wall
Street’s and of the wider economy’s woes.
It is cities that must watch their residents being evicted, their homes being emptied,
their houses deteriorating, their property values plummeting, their tax bases dwindling, their
services retrenching, their crime levels spiking, and so on and on. But they don’t have to lie
back and watch. They can act, and act now. They exist to address problems like these.
Protecting the citizenry and heading off blight is what municipal eminent domain authority is
for. It’s why we have it. And it’s why municipalities, rather than states directly or the federal
government, are those entities that most often employ it.
The Plan grows from this simple fact. It is accordingly for municipalities, or joint powers
authorities (JPAs) that they or their states establish to enable coordination among multiple
municipalities, to discharge their legally appointed function by customary, legally familiar
means. And it is for them to do so in partnership with private investors who effectively render
the Plan publicly costless – just as we’ve done since the earliest days of our republic in carrying
out and financing local projects.
Here is how it works. We begin schematically, then steadily fill in detail.
For purposes of exposition we shall again assume a particular municipality. Again that
will be the California county of San Bernardino, or a Joint Powers Authority (“Authority”) that
San Bernardino or California establishes to facilitate collaboration among multiple
municipalities. Now, in partnership with lending institutions and employing its traditional
eminent domain power, the County or Authority will purchase, at fair market value, temporary
possession of carefully selected underwater mortgage loans and liens on properties located
within its jurisdiction – to facilitate refinance the same. 98
98

For reminder of why San Bernardino, California makes for an illustrative case study, please see supra, note
54 and accompanying text. We say that possession of the purchased mortgages is, for the most part, “temporary”
in two senses. First, the purchased mortgage note obligations and attendant mortgages securing them are
discharged and extinguished upon repayment. Second, most of the new loans and attendant mortgages that
replace the antecedent ones are conveyed to new trusts that become the new mortgagees. The municipalities, in

29

Once it has purchased possession, the County or Authority will work directly with each
willing mortgagor within its jurisdiction to accept a “short” – that is, discounted – repayment of
that mortgagor’s obligations. It will do so in an amount corresponding to the level at which the
mortgagor can obtain new financing in the current mortgage loan market.
As mentioned, municipalities or authorities, financed by private investors, will pay just
compensation to current loan and lien holders in purchasing the select loans and liens, as
required by both state and federal law. 99 Applicable California law, which defines the eminent
domain authority somewhat more narrowly than does the U.S. Constitution, 100 pegs just
compensation at what it terms “fair market value.” This it defines as a price apt to be reached
by counterparties bargaining at arm’s length under orderly market conditions. 101
Municipalities or authorities acting on the Plan in California and counterpart states
might accordingly sometimes be paying more for the affected loans and liens even than many
private market participants themselves would now value them, under those still self-worsening
other words, do not simply become permanent state-level counterparts to the GSEs. A partial exception to the
general case here is the case of any borrower who might ultimately prove non-refinancable, in whose case the
municipality or joint powers authority will sell the loan on the whole loan market in states that permit this, while
holding them in states that do not. (California permits its municipalities such sales, Florida and Nevada at present
do not.) Investors collaborating with the municipality or joint powers authority bear the risk in all cases, which, for
reasons elaborated throughout this Memorandum and further substantiated in Appendix A, is significantly lower
than is the risk of widespread default and attendant value loss in connection with non-refinanced underwater
mortgages.
The bases on which mortgages are selected for acquisition is more fully elaborated below. The shortplaying version is that the first selected mortgagors must be current on their obligations – hence good credit risks –
and owe on significantly underwater mortgage obligations – hence strapped by severe post-bubble conditions that
they had no more reason than did lenders to anticipate. Some communities might of course subsequently select
mortgages pursuant to broader criteria, as determined per their own legislative judgment. The Plan is, in other
words, sufficiently adaptable as to be fine-tuned from community to community in manners responsive to those
communities’ particular needs. It should also be noted, if only in passing, that most mortgages securing real
property debts in our sample state of California are actually “deeds of trust.” For present purposes, however – or
for most any other purpose, for that matter – no practical difference is introduced by this distinction. See
th
generally 4 WITKIN, SUMMARY OF CALIFORNIA LAW: SECURITY TRANSACTIONS IN REAL PROPERTY, § 5 at 795 (10 ed. 2005).
99
“Fair market value,” which is California’s legally mandated understanding of just compensation, might
even exceed current market value in view of the ongoing and still self-worsening slump whose structural dynamics
we have characterized above in Sections I and II. This is one sense in which creditors themselves benefit by the
Plan. See infra, notes 101-104, and associated text for more on this matter. Also infra, Section IV.
100
Cites.
101
See Cal. Civ. Pr. §§ 1263.310 and 1263.320(a). See infra, Section IV, for full text. Fair market value would
accordingly be higher for, say, a property just outside the zone of danger deemed by authorities to surround Three
Mile Island than could likely be had in the actual market for such properties post-1978. By the same token it would
be lower for, say, the last property sold on the outskirts of territory recently announced to be slated for a new
Vandenberg Air Force Base than the actual market assigned to such property immediately following that 1950s-era
announcement. More on these matters infra, Section IV.

30

market conditions outlined and quantified above throughout Sections I and II. For these, recall,
are conditions that, again for the reasons elaborated in Section II, bear no inherent tendency to
change. Indeed they’ll continue to worsen unless and until municipalities or joint powers
authorities act per the Plan we elaborate.102
It is precisely this fact – the fact that concerted action taken by the municipalities will, in
solving the collective action problems that underwrite all of the ongoing ill health that we find
in our mortgage markets – which accounts for private market participants’ willingness to
finance the condemnations in the manner next to be described. More, then, on that.
Municipalities or authorities acting on the Plan will pay for the mortgage-associated
loans and liens of which they take legal possession with funds supplied by the aforementioned
private sector investing institutions.103 Among these investing institutions – which, notably,
may include current loan and lien holders themselves, indirectly through MBS 104 – will be one
or more of the following: public and private pension funds, insurance companies, mutual funds
and other investment firms. 105
Investors apt to be attracted by the Plan include in particular such as might wish to
replace presently troubled and default-prone mortgage loans with safer assets, either in their
own portfolios or in the portfolios they manage for others in fiduciary capacities. As suggested
above in Section II, that might mean even the GSEs – Fannie and Freddie, who by participating
in the Plan can maximize portfolio value and facilitate principal write downs in the public
interest without having to make hefty HAMP PRA “incentive” payments to servicers.
Now to the condemnation process itself.

102

Precisely because current conditions are rooted in coordination impasse as elaborated in Sections I and II.
See in particular, in this connection, the statistics elaborated in Section II.
103
While the private sector investors will initially be acting as lenders of a joint powers authority or other offbalance-sheet entity established by the municipalities to receive the condemned mortgage loans/liens, the
transaction constitutes part of a forward purchase by those investors of new mortgage securities that will come
forth pursuant to the Plan’s execution. There is a sense here in which investors are effectively partnering with
municipalities. They are doing so pursuant to an arrangement in which the municipalities now act in the name of
all interested parties, per the terms of Sections I and II above, as that one collective agent which is able to solve
the collective action problems that all mortgage securities investors and their obligors currently face when
contemplating the desirable prospect of value-salvaging loan restructuring.
104
This should not be surprising, given the rootedness of current market-undervaluation of these
institutions’ mortgage loan and lien holdings in impassible coordination problems that they face and the
municipalities now solves in their name.
105
Please see supra, notes 101-104. Also infra, Section IV.

31

At the commencement of planned condemnation proceedings, the municipalities or
authorities will deposit the mentioned investor-supplied funds, as required by states’ eminent
domain statutes, in state-administered escrow accounts maintained for the purpose. The
deposited amount in each particular case will, again as mandated by law, be set equal to the
probable just compensation ultimately to be paid for the mortgage loans and liens that the
given municipality condemns.
Under “quick take” eminent domain procedures such as apply in California and many
other states, probable just compensation is determined up front via municipality-procured
appraisals. Funds then are deposited into the aforementioned escrow accounts at the time
that the condemnation motions are filed. Once final compensation amounts have been
subsequently determined by loan and lien holders and the condemning municipality – either
with or without court assistance – any overage left in the escrow accounts will be equitably
distributed among loan and lien holders, donated to qualified housing charities through a
program administered by a respected national eleemosynary foundation, or both.
Once underwater loans are acquired, each municipality or authority will, in cooperation
with the consortium of designated participants in the financial services industry who supply the
upfront funding, ultimately accept discounted repayment of the loans from qualifying
mortgagors who have opted in to the Plan. Repayment of the acquired loans is effected by reunderwriting and refinancing participating mortgagors pursuant to criteria commonly employed
by ordinary market lenders and guarantors like the Federal Housing Administration (FHA). This
way the Plan ensures that the new loans are particularly safe and sound. 106
Additional substantive eligibility criteria, at least in the Plan’s early stages when erring
on the side of caution is prudent, are as follows.
First, the Plan will apply only to single family, owner-occupied residences within each
municipality’s jurisdiction. Second, all existing qualifying first lien mortgage loans will have loan
to value ratios (LTVs) greater than 100%. Third, the aggregate fair market value of loans or liens
secured by any qualifying home is to total to 85% or less of the value of the home itself, as
determined by quantitative valuation methods developed by the municipalities’ in partnership
with qualified mortgage finance professionals.107

106

Departure from traditional, and historically highly successful, FHA underwriting criteria was a hallmark, of
course, of the notorious nonprime loans that grew popular during the final phase of the bubble. See Hockett,
Bailouts, Buy-Ins, and Ballyhoo, supra note 72; also MORRIS, supra note 52.
107
Please see Appendix A, below, for technical specifications.

32

Finally fourth, the value of qualifying homes will not exceed 105.3% of FHA approved
loan amounts – thus permitting a 95% new loan to value ratio. 108 As it happens, our sample
state of California is the situs of just under 1.5 million mortgage loans meeting these categorical
criteria. 109
Other states and municipalities will of course be the situs of different numbers of
mortgage loans meeting the criteria, and all states over time will presumably adjust the criteria
in keeping with their own local needs and legislative judgments. This responsiveness to specific
state and local conditions is indeed one of the particular strengths of the Plan. Rather than
requiring one or two entities with national scope to deal in “one size fits all” terms with
thousands of servicers, per the concerns expressed by FHFA as noted above in note 92, the Plan
enables localities flexibly to tailor criteria to varying local circumstances, as well as to deal with
much smaller numbers of trustees and servicers, more on which momentarily.
Along with the categorical criteria just elaborated, the Plan contemplates possible use of
several additional, somewhat more open-ended substantive criteria in “prioritizing”
mortgagors. First, priority will likely be given at first to those homeowners who appear, on the
basis of existing loan level information including credit history and the mortgaged property
itself, to qualify for refinancing into new FHA first mortgage loans of 95% LTV. That is again an
“err on the side of caution” principle, based on the high success rates of FHA-conforming
mortgage loans over the past 80 years.
Second, priority will preliminarily be given to first mortgage loans held in private label
securitization trusts (PLSTs), as well as associated second mortgage liens. This is in order to
minimize the number of parties with whom municipalities must negotiate in purchasing
qualifying loans and repayment rights – thereby preventing replication of the coordination
challenges that necessitate local action in the first place.
Once the Plan is fully underway, municipalities or authorities will presumably conduct
further iterations in which non-PLST-held loans likewise are purchased and refinanced in
cooperation with obligors. It appears that California is the situs of approximately 565,700
mortgage loans – 38% of all underwater such loans – held in PLSTs.110
A particular municipality such as San Bernardino County might reasonably anticipate
that some 6,000 homeowners, with mortgage loans held by some 4,000 PLSTs managed by
108
109
110

See again infra, Appendix A, for fuller technical explication, explanation, and justification of these criteria.
Cite forthcoming.
Basis forthcoming.

33

merely twelve trustees, will complete the opt-in process during the first phase of its use of the
Plan after acquiring the qualifying mortgage loans. These loans might just as reasonably be
expected to possess an average fair market value, as this term of art is defined under California
law, of somewhere in the neighborhood of $150,000. 111 The County, in turn, might determine
to err on the side of caution by placing, say, $1 billion into the aforementioned state-managed
escrow account on behalf of the PLSTs from which it will purchase the loans.
The County or Authority in most cases also will treat together all loans in connection
with which any specific trustee acts on behalf of some PLST presently holding the loans. That
again enables a county like San Bernardino effectively to eliminate the coordination challenges
that have blocked loan restructuring thus far among its first 6,000 qualifying residents and
many thousands – if not millions – of dispersed PLST bondholders. For it will now be
negotiating with a mere twelve trustees. The new, refinanced loans that replace the old,
underwater loans will then ultimately be grouped together again, with the partnering
institutions that finance the municipalities’ purchases holding the resultant bonds.
In effect, each municipality or authority that adopts and acts on the Plan will be taking
possession of mortgage loans to resolve and refinance them – in short, to negotiate EVmaximizing principal write downs that lenders and borrowers alike wish to see but cannot
separately negotiate in light of the impediments catalogued in Section II. In so doing it will also
be accepting discounted repayment in the form of proceeds from new mortgage loans. These
latter in turn are originated specifically for the purpose of conveyance to participating private
investors, as repayment in kind of the moneys that the investors lend the municipality upfront
to finance the condemnation award. 112
In operating pursuant to the Plan, each municipality will have preserved neighborhood
integrity, property values, and the revenue base from which it funds services. It will have kept
its own residents in their own homes – still owning and paying on them rather than falling into
default and foreclosure that harms lenders nearly as much as it does borrowers. It will also
have enabled residents to get out from under the debt overhang that for six years and counting
has increasingly to imperiled not only them, but their lenders, their neighbors, and the state,
local, and national economies to boot.

111

See infra, note 142, and associated text for more on the technical meaning of “fair market value” under
California law. The dollar figure is from DQ NEWS.
112
As noted supra, note 98, there might be a small cohort of mortgage loans that, for one reason or other,
ultimately prove not to be refinancable. Such loans of this description as might emerge will be sold by
municipalities in the “whole loan” market for cash, which cash will then also be returned to investors.

34

In short, the Municipal Plan is an efficient and Solomonic solution that treats everyone
fairly and protects countless third parties against the immensely destructive spillover
consequences of mass foreclosure as well. There has never been a more fitting use of the
states’ traditional eminent domain authority.

IV. The Plan’s Constitutional Basis and Legal-Procedural Details
The Municipal Plan makes essential use of the states’ and their instrumentalities’
traditional eminent domain authority. It will accordingly be helpful now to lay out the broad
contours of this authority and its applicability to the purposes pursuant to which the Plan
employs it. That way we lay out the structure of this, legal “layer” of the Plan just as Section III
has laid out the structure of its financial “layer.” 113
The two layers together constitute the entirety of the Plan much as a contour map
captures a salient entirety of a geographical region. In an important sense, however, the legal
layer is more “fundamental.” For the states can act only in keeping with their legal authority,
Plan or no Plan. On, then, to this authority on the basis of which the Plan envisages states and
municipalities acting.
The eminent domain authority is of longstanding in both the civil and common law
traditions. Even as early an articulation of the authority as that found in Grotius’s De Jure Belli
et Pacis reads strikingly like contemporary articulations.114 The guiding idea behind eminent
domain might be better conveyed in contemporary terms by substituting the now more familiar
“preeminent” and “dominion” for the more archaic “eminent” and “domain.”

113

Because this Memorandum is meant to be intelligible to non-lawyers, there is more in the way of
background explanation, and somewhat less in the way of luxuriant citation to authority, here than there would in
an appellate brief of the sort that the author is accustomed to penning. A sample such brief, formatted and citing
as such briefs themselves do, appears as Appendix B – the legal counterpart to that sample financial term sheet
that appears as Appendix A. All constitutional, statutory, and case-legal authority relied upon in this Section,
however, still is cited in full. There simply will not be citations for literally every sentence as is generally the case in
briefs filed in court.
114
Here is Grotius: “The property of subjects is under the eminent domain of the state, so that the state or
he who acts for it may use and even alienate and destroy such property, not only in the case of extreme necessity,
. . . but for ends of public utility, to which ends . . . private ends should give way. But it is to be added that when
this is done the state is bound to make good the loss to those who lose their property." See HUIG DE GROOT
(“Grotius”), DE JURE BELLI ET PACIS (“The Law of War and Peace”) (1625), available online at
http://www.lonang.com/exlibris/grotius/index.html. (For more on Grotius, see ROBERT HOCKETT, THE LITTLE BOOK OF
BIG IDEAS: LAW (2009).) Contemporary articulations of the eminent domain authority to follow.

35

The gist of “preeminent dominion” is that any sovereign authority – the nation, a state,
or some other fundamental unit of government – so long as it acts on behalf and in the name of
the people, holds a dominion over property within its jurisdiction that is implicitly prior to that
of any particular individual. This it may sparingly exercise as against any subordinate private
dominion over the property in question, when and only when necessary for the good of all,
provided it pay just compensation when so doing.
Because this authority is as plenary as the sovereign’s jurisdiction itself and accordingly
operates, like the relevant unit of government itself, in the name of the sovereign public or
people as a whole, it is applicable to all forms of property – real or personal, tangible or
intangible, integral or fragmentary. A unit of government that can exercise personal jurisdiction
and thereby “haul you into court,” try you, condemn you, imprison or even execute you,
unsurprisingly, can exercise in rem jurisdiction over and “condemn” your inanimate possessions
as well. The question’s not whether, but how – within what limitations.
The only inherent limitations on the eminent domain authority are already implicit in
the characterizations just given. As it is ultimately the public’s or people’s authority – in the
U.S., the authority of that “We, the people,” who speak in the Preamble to the Constitution – it
can only be exercised for a purpose of the people: a public purpose. And, presumably because
a guiding principle of that social contractarian legal and political ideal that has been part of the
American ethos since at least the time of that favorite of the American Founders, John Locke,
has been that citizens should not be made worse off for being members of a polity than they
would have been in a “state of nature,” the public holds itself bound also to compensate any of
its members against whose privately held property it exercises its eminent domain authority.
These are the apposite “first principles,” which antedate the American founding and
find their way into American law via the British common law that we adopted, then adapted,
from the colonial era on down to the present. An additional wrinkle is introduced in the
American case, however, by the federal system of government that we also embraced with our
Constitution. Pursuant to the “dual sovereignty” exercised by state and federal governments
alike under our system, both sites of sovereignty hold powers of eminent domain. All that
differs between them, in essence, is the identity of the relevant “public” – or, in the terms of
Sections I through III above, the relevant “collectivity” – on whose behalf each government acts
as collective agent.
To remain with our earlier, not quite randomly selected example, then, California’s state
government exercises its eminent domain authority in the name of and on behalf of
Californians as residents of California. The federal government exercises its counterpart
36

eminent domain authority in the name of and on behalf of Americans as citizens of the U.S. Of
course this means also that California’s exercise of its eminent domain authority will be
conducted pursuant to a “public purpose” understood in reference to the public of California –
the Californian citizenry – while the federal government’s such exercises are symmetrically
taken for purposes of the full U.S. citizenry.
Exercises of the eminent domain or any other authority by these distinct sovereigns may
collaterally benefit other “publics” that they do not represent, of course. U.S. clean air
standards presumably benefit many outside of the U.S. just as surely as U.S. carbon emissions
might induce acid rain elsewhere, for example. But the exercise of authority must always be
capable of being justified by reference to that public which actually authorizes the government
in question to act in its name.
It is also the case, of course, that citizens of California are likewise citizens of the U.S.,
meaning that there is overlap among the “publics” who are implicated by the U.S. and
Californian “public purposes” for which U.S. and Californian eminent domain authority might be
exercised. How then are those purposes distinguished? Here it is helpful to recur once again to
the notion of a collective action problem of the sort that figures prominently in Sections I
through III. In essence, our constitutional arrangement is such as to observe principles of what
in other parts of the world are called “subsidiarity.”
The basic subsidiarian idea, which the U.S. honors under several distinct terminologies –
one such of course being “federalism” – boils down to this: Where satisfaction of some
particular interest requires addressing a collective action challenge that afflicts some group of n
persons and no more, in general the smallest unit of government with jurisdiction over those n
persons should be charged with satisfying that interest.
The interest of national defense, for example, and the collective-action-redolent “free
rider problem” that imperils it, is inherently national in scope in the sense that national forces
are needed and all national citizens must be taxed to finance them, even when there are or
have been state National Guard units or militias. The interest of policing a neighborhood, by
contrast, and the free rider problem that imperils it, is straightforwardly local and can be
handled and tax-financed accordingly. 115
115

Unless of course there is a national interest in rough equality of service quality nationwide, which as an
inherently national interest would in some circumstances bring federal subsidies to underserved localities,
financed via federal revenues. Counterpart remarks hold for education, water quality, etc., many of which
th
implicate either the Equal Protection Clause of the 14 Amendment to the U.S. Constitution or political and hence
legislative values that find partial expression therein. Of course where schooling is concerned, the Clause itself has
been held to require very little, alas. See San Antonio Ind. Sch. Dist. v. Rodriguez, 411 U.S. 1 (1973).

37

In between these two “highest” and “lowest” levels of government, national
subdivisions like states, or coalitions thereof, will be best suited to handling certain matters
that affect multiple cities or townships within their jurisdictions while not affecting any outside
of them – matters concerning the management of certain shared rivers or lakes, for example.
An important feature of the American rendition of subsidiarity for present purposes is
its vesting jurisdiction over matters of real property, trust and estates, contract, and
commercial law – the stuff of housing, home-ownership, real estate and mortgage finance –
almost exclusively with the states.116 Legal-doctrinally speaking, that vesting takes the form of
states’ reservation, via the Constitution’s 10th Amendment, of what is known as a residual
“police power” over matters not expressly or impliedly placed under immediate or optional
federal jurisdiction by other provisions of the Constitution.
“Police” here, importantly, is to be understood in the sense of “policy” rather than
“constable,” though the term definitely embraces the notion of states’ roles as protectors of
their citizens, and in that sense as regulators of activities that can harm or pose significant risks
to them. This is, again, a residual plenary authority, understood as that fundamental baseline
from which the federal constitution’s so-called “enumerated powers” constitute only discrete,
limited, conditional exceptions.
States’ or their instrumentalities’ roles as collective agents in this context, then, as
suggested in introducing this Section above, can be viewed as occupying a “contract-andproperty-legal layer” over which their roles as collective agents as suggested in Section III serve
as a “mortgage-financial overlay.” Fundamentally, state governments exercise their police
powers, of which the eminent domain power is but one, both in the name of and on behalf of
the collectivity of their citizens – most of whom are home owners and neighborhood dwellers,
and many of whom are borrowers and lenders.
Collaterally, though, in some cases of so doing they will also be assisting their citizens in
the resolution of collective action problems that these citizens face in conjunction with out-of-

116

Hence all states have their own property codes, and nearly all have their own versions of the Uniform
Commercial Code (UCC), Article 2 of which covers commercial contracts, Article 9 of which covers secured
transactions including mortgage-secured such transactions, and Article 3 of which covers negotiable instruments
including promissory notes of the sort mortgagors convey to mortgagees. Significantly, there is no “national”
property code, nor is there any national commercial code, the “uniformity” of the UCC signifying an aspiration of
the drafters and Permanent Editorial Board (PEB) that states voluntarily harmonize precisely because there is no
federally imposed uniformity. See generally Hockett, Six Years On and Still Counting, supra note 3.

38

state others to whom they relate in contract, so as effectively to benefit all. This is, of course,
what we have found in connection with the Municipal Plan elaborated above in Section III.
In the just mentioned interstate contracting connection it of course bears noting that it
is a commonplace of the American constitutional order that jurisdiction over matters
concerning inherently or undeniably interstate commerce can be exercised by the federal
legislature. It is not quite as commonplace, but at least is notorious to many a law student past
the first year, that some such matters are thought to be so essentially interstate in character as
to count as implicitly required to be kept uniform across states even when Congress has not
affirmatively acted so to require. 117
But what is most striking against this backdrop is how much our constitutional order
nevertheless reserves to the states – and, in particular, how matters of contract, commercial,
and especially property law continue to be almost entirely matters of state law under that
order. We really do remain, in a significant sense, a sort of “compact of states.”
One more wrinkle important to note in connection with both our federated form of
subsidiarity and the place of the eminent domain authority in American law comes with the role
of municipalities in our system. Because the federal Constitution was historically a compact
entered into by what were viewed as thirteen antecedently sovereign states, states are
effectively viewed as being among the original delegators of authority in our system.
The federal government’s being a creature of “the People” independently of the states,
as suggested by the Preamble to the Constitution, finds expression, legislatively speaking, in the
House of Representatives, wherein states are represented in proportion to their populations.
But the federal government’s being also and simultaneously a creature of the states also finds
expression in our national legislature – in this case via the Senate, wherein each state is
represented, as a state, by the same number of Senators.
If states share their delegation of authority with “the people” of the nation as a whole
where federal governance is concerned, however, they are the sole delegators of authority to
their own municipalities. They are not viewed under our law as “compacts” or “federations” of
117

This is the domain of the so-called “dormant,” or “implicit” Commerce Clause, essentially interpreted as a
prohibition on protectionism on the part of states of firms located within them at the expense of competing firms
located in other states – a sort of GATT or WTO of the states. Notorious examples include South Carolina’s once
prohibiting delivery trucks of a particular size from using its highways, widely recognized as a means of protecting
local producers against imports from neighboring-state competitors. People who fret over “judicial activism” are
among those who most loathe the notion of a “dormant” Commerce Clause. If it’s asleep, let it lie until Congress
expressly awakens it, they in effect complain.

39

their cities and towns, in other words, as the federal government is viewed as a federation of
“united” “states.” Instead the term that the law uses in this context is “creatures.”
Municipalities are “creatures of state law,” just as are trusts, corporations, and other legal
entities. Indeed, in most states, municipalities are in fact legally known as “municipal
corporations,” from whence derives the notion of “incorporating” a town.
The significance of this relation between state and municipality for present purposes is
twofold. First, even when employed by municipalities, as it typically is pursuant to state
delegation under “home rule” or cognate statutes, the eminent domain authority is state
authority. In that sense it is located at the very core of our federal system of government – a
species of authority that belongs to the states quite as fully, if not indeed more so, as it does to
the federal government.
Second, in delegating the eminent domain power to their municipalities as states
generally do, they are delegating it to entities that are in a certain sense “on a level” with other
organized entities created under state law – even private such entities such as trusts. Hence it
is unsurprising that municipalities often work in partnership with other entities in pursuing
public purposes through use of the eminent domain power – as the Municipal Plan itself
envisages. This has been the way of eminent domain since the earliest days of our republic.
That takes us on to the Municipal Plan in particular and its status as a familiar and
altogether orthodox exercise of the eminent domain power. For expository purposes noted
above in note 54 and the text that accompanies it, we shall once again assume use of the Plan
in a particular state: California. For the same purposes we shall also assume the same county as
before: San Bernardino.
Taking some other state or municipality for our illustrative example might affect the
analysis we shall now undertake at the margin, but only at the margin. That is because all of
the states’ eminent domain regimes are quite similar. All one would have to do to apply the
forthcoming analysis to a different state and municipality would be to cite distinct state
constitutional, statutory, and municipal provisions as well as judicial constructions thereof, and
then accommodate such minor terminological wrinkles as these variations would introduce.
Back to California and San Bernardino, then, for purposes of the present hypothetical
legal analysis. The Municipal Plan’s use of eminent domain authority will be subject both to the
federal and to the state constitutions – first the latter, then the former as a final check on the
latter. The California provision on point is article I, Section 19 of the state’s Constitution.
Subsection (a) thereof reads
40

Private property may be taken or damaged for a public
use and only when just compensation, ascertained by a jury unless
waived, has first been paid to, or into court for, the owner. The
Legislature may provide for possession by the condemnor following
commencement of eminent domain proceedings upon deposit in court and
prompt release to the owner of money determined by the court to be
118
the probable amount of just compensation.

The “public use” and “just compensation” limitations are of course common – so much so that
the introductory discussion above, it might have been noted, employed the same terminology
without reference to any particular state or federal constitutional provision. The referenced
requirement to place potential condemnation award moneys – the prospective just
compensation – in escrow is likewise common, and is of course one reason for provision to do
so in the Municipal Plan as laid out above in Section III.
The applicable federal constitutional provision on point, the so-called “Takings Clause”
of the Fifth Amendment, is no more restrictive than the California provision. 119 Indeed if
anything, it is less so. For the U.S. Supreme Court notoriously has interpreted the provision to
allow government condemnation of private residences for purposes of conveying them to
private parties in the name of economic development.120 California, by contrast, is more
arguably solicitous of homeowners’ interest in remaining in their homes. Hence it purports to
forbid Kelo-style taking in subsection (b) of the aforecited Section 19.121 In general, however,
the U.S. and California provisions are sufficiently in agreement as to underwrite California
courts’ regularly citing to both state and federal decisions in cases involving the exercise of
eminent domain in the state.122
Next, as noted above, eminent domain authority is exercisable over all forms of
property – real or personal, simple or fragmentary, tangible or intangible. That, again, is the
118

Cal. Const. art. I, § 19 (a).
U.S. Const., amend. V (“. . . nor shall private property be taken for public use, without just
compensation.”). What is perhaps most noteworthy about this clause is the fact that it presupposes that private
property regularly is, and accordingly may, be taken for public use, with the clause purporting to restrict the
common practice only by reiterating that just compensation is to be paid.
120
Kelo v. City of New London, 545 U.S. 469 (2005).
121
Cal. Const. art. I, § 19 (b) (“The State and local governments are prohibited from acquiring by eminent
domain an owner-occupied residence for the purpose of conveying it to a private person.”). It should perhaps be
noted, if only in passing, that subsections (c) and (d) go on to limit subsection (b) itself somewhat, in the form of
familiar exceptions for public health or public works projects.
122
See County of Ventura v. Channel Islands Marina, Inc., 159 Cal. App. 4th 615 (2008). Given the post-Kelo
date of this cited decision, on the one hand, and the exceptions to subsection (b) of the section 19 of the California
Constitution’s article I cited in the previous note, there might be some reason to question whether California
takings law is indeed more restrictive than federal takings law under Kelo, as I suggested above.
119

41

case everywhere that eminent domain authority is recognized, be it in civil or common law
jurisdictions.
Under the federal rendition of this authority, for its part, the U.S. Supreme Court and
the Courts of Appeals have regularly held that the authority extends, for example, to contract
rights,123 insurance policies, 124 shares of stock, 125 businesses as going concerns, 126 hunting
rights,127 rights of way, 128 and all manner of additional intangible. U.S. states follow the same
longstanding common law tradition as does federal law in this connection. 129 California’s
Supreme Court, for example, long has explicitly recognized that “[the state’s] eminent domain
law authorizes the taking of intangible property.” 130
In view of the law’s drawing no distinctions between kinds of property that can be
condemned in eminent domain proceedings, it should come as no surprise that liens in
particular, as merely one form of contractual obligation among many, all of which can be
condemned, are themselves regularly condemned. 131 Among those liens are, of course,
mortgage loans and liens, as the U.S. Supreme Court and other state courts have recognized.132
Hence, again, the explicit recognition by the California Supreme Court, too, that “[n]o
constitutional restriction, federal or state, purports to limit the nature of the property that may
be taken by eminent domain.” 133
The only complication at all that is introduced into eminent domain analysis by
intangible property has to do with the effect that intangibility has on state courts’ jurisdiction,
since intangibles cannot be literally, spatially “located.” The law has long been aware of the
123

See, e.g., United States Trust Company of New York v. New Jersey, 431 U.S. 1, 19 (1977).
See, e.g., Lynch v. United States, 292 U.S. 571, 577-79 (1934).
125
See, e.g., Offield v. New York, New Haven & Hartford R.R. Co., 203 U.S. 372 (1906).
126
See, e.g., Kimball Laundry Co. v. United States, 338 U.S. 1 (1949).
127
See, e.g., Swan Lake Hunting Club v. United States, 381 F.2d 238 (5th Cir. 1967).
128
See, e.g., City of Cincinnati v. Louisville & Nashville Railroad Co., 223 U.S. 390 (1912).
129
See, e.g., New York, N.H. & H.R. Co. v. Offield, 59 A. 510 (Conn. 1904) (Connecticut, condemning stock);
Spencer v. Seaboard Air Line Ry. Co., 49 S.E. 96 (N.C. 1904) (North Carolina, condemning stock).
130
City of Oakland v. Oakland Raiders, 32 Cal.3d 60, 68 (2008) (condemning a sports franchise).
131
See, e.g., Phillips v. Washington Legal Foundation, 524 U.S. 156 (1998) (accrued interest on account
funds); Armstrong v. United States, 364 U.S. 40 (1960) (materialman’s lien); and the iconic Legal Tender Cases, 79
U.S. (12 Wall.) 457 (1870).
132
See, e.g., Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 602 (“If the public interest requires . . .
the taking of property of individual mortgagees in order to relieve the necessities of individual mortgagors, resort
must be had to proceedings by eminent domain.”); W. Fertilizer & Cordage Co. v. City of Alliance, 504 N.W.2d 808,
816 (Neb. 1993) (Nebraska Supreme Court holding that “a mortgagee’s lien on real estate is an interest that may
be subjected to a taking for a public purpose and, therefore, may be the subject of an eminent domain
proceeding.”).
133
Oakland Raiders, supra note 130, 32 Cal.3d at 67.
124

42

fact that intangibles are not tangible and accordingly not spatially located, however, and its
doctrines have responded accordingly.
Because the doctrines of due process, in personam, in rem, territorial and subject
matter jurisdiction through which it does so are particularly complex and technical both in
themselves and in their interactions, though, it will be well to defer fuller technical treatment to
the technical-legal appendix that is Appendix B. 134 For present purposes it will suffice to
observe that in general, courts find the situs of a debt instrument to be in the domiciliary state
of the debtor, 135 and the situs of real estate mortgage debt in particular to be the state in which
the mortgaged property is itself located.136
It will be noted that where the mortgage debtor is domiciled in the mortgaged home
itself, as is in fact required to qualify for loan modification under the Municipal Plan as
elaborated in Section III, both of the aforementioned grounds of state jurisdiction converge.
This entails that the state enjoys both in rem jurisdiction over the debt and the property
securing it, and due process-consistent in personam jurisdiction over the creditor/mortgagee,
both of these ultimately in virtue of the territorial jurisdiction it has over the space in which the
mortgagee and her home are respectively domiciled and located. Subject matter jurisdiction,
for its part, is here a matter of traditional state authority delegated to municipalities, more on
which presently.
Federal and state constitutional authority to exercise the eminent domain power over
intangibles like mortgage notes as contemplated by the Municipal Plan, then, is secure. The
same holds of power to transfer acquired such property – tangible as well as intangible – to
private entities. In the case of federal law, of course, the latest and most oft-cited word on the
matter is the U.S. Supreme Court’s 2005 Kelo decision mentioned above. California, as also
noted above, is sufficiently solicitous of the interest of homeowners in staying in their homes as
to limit condemnation of residences for purposes of transfer to private entities. That is of
134

The author taught Civil Procedure I and Civil Procedure II in the legal academy during his final year as a
doctoral student. The first of those courses is in its entirety devoted to the subject of jurisdiction, which involves
not only codes of procedure, but such constitutional interests as due process. He trusts that the reader would
rather this full semester course be summarized in an appendix than over multiple pages within the present text.
135
See, e.g., the old chestnuts, beloved of all professors and students of Civil Procedure, Harris v. Balk, 198
U.S. 215 (1905); and Chicago, Rock Isl. & Pac. Ry. Co. v. Sturm, 174 U.S. 710 (1899). In California in particular, see
Waite v. Waite, 6 Cal.3d 461 (1972).
136
Here the jurisdiction is mediated by the unseverable link between mortgage and note. See Carpenter v.
Longan, 83 U.S. 271, 274 (“The note and the mortgage are inseparable.”); and Hyde v. Mangan, 88 Cal. 319, 327
(1891) (“The debt and security are inseparable; the mortgage alone is not a subject of transfer.”). For more on this
matter, and its consequent wedding of inherently state-centric property and commercial law, see Hockett, Six
Years On and Still Counting, supra note 3.

43

course good news for the constitutionality of the Municipal Plan, a principal purpose of which is
precisely to prevent foreclosures, evictions, and expropriation of homeowners.
Also good news is the fact that California is as open as is the U.S. Supreme Court to
transfer of condemned intangibles, as likewise contemplated in the Municipal Plan. The only
restriction in this case is the earlier discussed public purpose requirement that is at the heart of
the eminent domain power, to the precise contours of which under U.S. and California law we
shall turn in due course. California’s authorization of the transfer of condemned intangibles is
found in its Code of Civil Procedure, 137 and is well recognized by the state’s Supreme Court.138
The next thing to note is that, as suggested by the citation just made to California’s Code
of Civil Procedure, statutory law promulgated by state legislatures affords further guidance to
use of the eminent domain authority. To keep with our sample state – California – then, the
applicable law is, as just effectively noted, found in the state’s Code of Civil Procedure, Sections
1230.010-1273.050, known as the state’s Eminent Domain Law.
This Law, for its part, first requires that express statutory authority authorize any
particular government instrumentality’s use of the eminent domain power. 139 As for the
question of what such instrumentalities might do so, California conforms to the general
observations made above that (1) municipalities and joint powers authorities themselves
exercise these powers only insofar as states delegate them to them, while (2) most states do in
fact thus delegate them. Hence in California, municipalities and joint powers authorities (1)
exercise eminent domain authority “only when expressly authorized by law,” 140 while (2) they
are in fact expressly authorized by law to exercise this authority. 141
As in other states, statutory guidance also further contours the determination of what
counts as “just compensation” in California – that which must, again under both the Takings
Clause of the 5th Amendment to the U.S. Constitution and under Section 19 of Article I of the
California Constitution, be paid those whose property is condemned under the eminent domain
137

See Cal. Civ. Proc. § 1240.120(b) (property condemnable “with the intent to sell, lease, exchange, or
otherwise dispose of [the same]. . .”).
138
Oakland Raiders, supra note 130, 32 Cal.3d at 681-82 (“So long as adequate controls are imposed [to
ensure transfer to private entity itself furthers public purpose], there is no reason why the ‘public purpose’ which
justifies a taking may not be so served and protected.”).
139
See Section 1240.020 (“The power of eminent domain may be exercised to acquire property for a
particular use only by a person authorized by statute to exercise the power of eminent domain to acquire such
property for that use.”).
140
Oakland Raiders, supra note 124, 32 Cal.3d at 64. Also Civ. Proc. § 1240.020(b) (power exercisable “only
by a person authorized by statute to exercise [it].”).
141
See Cal. Govt. Code § 37350.5.

44

authority. California’s Eminent Domain Law provides that guidance in its Sections 1263.310 and
1263.320(a).
As mentioned above in Section III, the first stipulates that “fair market value” be paid for
the property taken. Also as mentioned above, the second unpacks “fair market value”
essentially as the highest price apt to be reached by willing counterparties bargaining under
conditions of unforced sale. 142 There will be more to say on this in Appendix A, which treats of
valuation matters in greater technical detail.
The final limitation upon the eminent domain authority about which a bit more should
be said is the “public purpose” requirement mentioned above with our first, preliminary
characterization of the authority. While the requirement has always been implicit in the
doctrine of eminent domain itself – since well before anyone knew there would one day be a
United States of America – the requirement finds more specific expression, again, in specific
provisions of federal and state law.
The applicable federal law is simply the Supreme Court’s elaboration of the public use
requirement implicit in the aforementioned Takings Clause. The applicable state law comprises
(1) the aforementioned Section 19 of Article I of the state’s Constitution, (2) California statutory
provisions to be considered presently, and (3) state judicial constructions of (1) and (2).
The basic grounding of state and municipal exercises of eminent domain authority
amounts to a kind of combined subject matter, personal, and territorial jurisdiction. It is the
“police power” mentioned above in preliminarily characterizing the doctrine of eminent domain
generally. The U.S. Constitution’s 10th Amendment specifically reserves this power to the
states, and most of the states in turn delegate portions of this power to their municipalities
along more or less subsidiarist lines as elaborated above. California does this through its
constitution’s article XI, Section 7, which provides that “[a] county or city may make and
enforce within its [territorial] limits all local, police, sanitary, and other ordinances and
regulations not in conflict with general laws.”

142

The statutory language reads thus: Fair market value is “the highest price on the date of valuation that
would be agreed to by a seller, being willing to sell but under no particular or urgent necessity for so doing, nor
obliged to sell, and a buyer, being ready, willing, and able to buy but under no particular necessity for so doing,
each dealing with the other with full knowledge of all the uses and purposes for which the property is reasonably
adaptable and available.” Further guidance is provided in the form of a stipulation that existing comparable
markets can be used in ascertaining the mentioned counterfactual “would.” Absent some such comparable
market, the Eminent Domain Law permits determination of “fair market value” as determined by any method of
valuation that is “just and equitable.” See Civ. Proc. § 1263.320(b). The discussion over Sections I through III
above, as well as that over Section IV below, would seem to have some bearing on what is just and equitable here.

45

As the catch-all “other ordinances” suggests, the police power is very broad – indeed a
“plenary authority to govern, subject only to the limitation that [the municipalities exercising
the power] exercise [it] within their territorial limits and subordinate to state law.” 143 Hence it
permits municipalities authority “to enact laws to promote public health, safety, morals and
general welfare.” 144
Presumably because (1) states and municipalities employ eminent domain authority in
exercising their police powers, while (2) these powers are themselves very broad per the
federal Constitution’s 10th Amendment, the U.S. Supreme Court’s construction of the eminent
domain public purpose requirement is very deferential to state and municipal legislative
judgments of public purpose. The best known exemplar is again the Court’s widely discussed
Kelo decision of 2005, in which the city of New London, Connecticut’s condemnation of homes
with relatively low market value for purposes of making land available to private developers
was upheld. The proffered public purpose in this case was economic development, which the
city thought a likely collateral benefit of the developers’ proposed facility. The Court for its part
recognized the interest in economic development as a legitimate “public use” for purposes of
the eminent domain authority.
Two other public purposes commonly recognized both by the Supreme Court and all
other courts in the U.S. are particularly apposite to the Municipal Plan. One is the long
recognized public interest in reversing or preventing blight. So venerable is this particular
purpose that the City of New London itself appealed to it in justifying the action mentioned
above.
More common appeals to the blight reversal or prevention interest ground themselves
in actual abandoned or decaying homes, emptying neighborhoods, overgrowing lawns,
crumbling roads and other infrastructure, and the like. 145 Again, not only reversal, but also
prevention of developments such as these – both of which the Municipal Plan by its terms aims
to effect – counts as a public use par excellence for purposes of justifying exercise of the
143

th

Suter v. City of Lafayette, 57 Cal.App.4 1109, 1118 (1997). Note that, structurally and functionally
speaking, the municipal/state relation is being characterized as analogous to the state/federal relation. All that
differs is the putative font of the authority in question, the conceit in the state/federal case being that the states
confer, along with “the People,” authority upon the “higher level” federal government, while in the
municipal/state case the conceit is the reverse, with the state delegating authority to the “lower level” municipal
governments. As mentioned earlier in this Section, however, the conceit is important, in that it imparts to our
federalism a tendency to treat states and their eminent domain as in a certain sense as or more “fundamental”
as/than the federal government and its eminent domain power. This might account for the high degree of U.S.
Supreme Court deference to state and local exercises of eminent domain, as discussed presently.
144
th
Community Memorial Hosp. v. County of Ventura, 50 Cal.App.4 199, 206 (1996).
145
Here the chestnut case is Berman v. Parker, 348 U.S. 26 (1954).

46

eminent domain authority. 146 Section V of this Memorandum, to which we proceed presently,
accordingly documents in detail the blight – indeed, blight that is unprecedented in magnitude
– now being wrought in multiple U.S. municipalities by the ongoing mortgage foreclosure crisis.
The second public purpose routinely upheld as legitimate in challenges to eminent
domain exercise is the interest in eliminating dislocations in local housing markets stemming
from lienholders’, servicers’, and other parties’ unwillingness to consent to short sales, deeds in
lieu of foreclosure, and the like – as well as counterpart inability of mortgagors to sell at current
market value or otherwise transfer property in satisfaction of mortgage debt. Like the blight
reversal and prevention interest, so is this one straightforwardly applicable to cases in which
the Municipal Plan will be pursued.
Here the best known U.S. Supreme Court decision is that handed down in the case of
Hawaii Housing Authority v. Midkiff,147 in which the Court found sufficient public interest in the
State of Hawaii’s wholesale condemnation of landlords’ ownership interests in real property in
order to convey the property to tenants. The purpose of the condemnation and transfer was to
“reduce the concentration of ownership of fees simple in the State,” which Hawaii had found
“responsible for skewing the State’s residential fee simple market, inflating land prices, and
injuring the public tranquility and welfare.” 148
Against the backdrop of Midkiff, it is difficult to imagine anyone’s finding the Municipal
Plan’s purposes anything other than fully public. The “landlords” in the present case, after all,
themselves overwhelmingly wish to write-down principal but are prevented from doing so by
the collective action challenges catalogued in Section II. They also, of course, hold property
rights that are much more attenuated than those of literal landlords, owning as they do only
repayment rights and security interests.
Current securitized mortgagees likewise are immeasurably more “absentee” than the
most absent of literal landlords, the form of their “absence” in this case – fragmented and
scattered all over the world as they are, knowing only their bond instruments, not the
properties that secure them – being precisely what stands in the way of their coming together
to write down principal as they would if they could. And finally, as noted above they are free
and invited in any event, per the terms of the Plan, to continue as owners by participating in the
investment that funds the Municipal Plan itself, the funders of which become the ultimate
resultant creditors.
146
147
148

Id.
467 U.S. 229 (1984).
Midkiff, id. at 232.

47

So much for the federal construal of public purpose. As noted above, California’s
understanding of “public use” tracks that of the federal courts. 149 There is accordingly little to
add in respect of its case law on point. It is worth noting, however, that the State’s Eminent
Domain Law (which we shall now label “EDL”) adds further statutory guidance, including with
respect to procedure. First, then, the EDL repeats the State’s constitutional requirement of
“public use.” 150 Next, the EDL requires that any municipality or other State instrumentality
such as a JPA authorized to employ the authority adopt, before doing so, a “resolution of
necessity” that explains the public use for which property is being condemned.151
The resolution for its part is adopted in an open legislative session, after a public hearing
on the question of necessity in which reasons for condemnation are proffered, debated, and
assessed. These familiar legislative procedural requirements are of course meant to ensure full
transparency, reasoned democratic deliberation, and fair access to all who might wish to take
part in those community proceedings in which municipalities contemplate use of their eminent
domain authority.
If and when a resolution of necessity is then adopted, the municipality obtains an
appraisal of the condemnable property as described above in Section III, places the appraised
amount in escrow, and files a condemnation action in California Superior Court.152 The
Municipal Plan can of course be adapted to incorporate within it all such procedural steps as
might be prescribed by any other participating state’s and municipality’s eminent domain
statutes and ordinances.
But who will these participating states and municipalities be, and why might they
participate? This question takes us straight to our final Section – which, by describing more
fully the imminent consequences of continued delay in implementing some variant of the
Municipal Plan in cities still at the core of our ongoing mortgage foreclosure crisis, both (1)
implicitly identifies municipalities that should find the Plan most attractive, while (2) rendering
clear just how urgent the public purpose these cities will have for pursuing the Plan will be.
149

th

See, again, County of Ventura v. Channel Islands Marina, Inc., 159 Cal.App.4 615, 624 (2008) (apart from
the aforementioned protection of residences from Kelo-style taking with a view to transferring to other private
parties, “California courts have construed the [counterpart federal and state takings provisions] congruently [and]
have analyzed takings claims under decisions of both the California and United States Supreme Courts.”).
150
See Civ. Proc. § 1240.010.
151
See Civ. Proc. § 1245.230. If the State Legislature has provided explicitly by statute that some particular
“use, purpose, object or function” is “one for which the power of eminent domain may be exercised,” then the
action is deemed to be a declaration by the Legislature itself that the use, purpose, object or function in question
in indeed a public use. See id., § 1240.010.
152
See Civ. Proc. § 1250.110.

48

V. The Plan’s Manifest Public Purpose and Urgent Necessity
We complete this Memorandum by discussing in a bit more detail what is currently
underway in those municipalities located at the center of our ongoing and self-worsening
mortgage foreclosure crisis. Specifically, we note the remarkable toll in family and
neighborhood suffering, ongoing and self-worsening value and revenue loss, and consequent
blight that rolling foreclosures are now actively bringing in their wake.
Closing on this note serves two critical purposes. One is to illustrate how squarely the
public purpose requirement, under which condemnation proceedings always proceed, is met by
the purposes that prompt the Municipal Plan laid out and legally analyzed in Sections III and IV.
Indeed, we shall see, we have here what amounts to a “textbook case” – and then some.
The other purpose we serve is empirically to substantiate, and afford more appreciation
of the true costs occasioned by, that financial and economic dynamic elaborated over the
course of Sections I and II. In effect, then, in this Section we further support both the legal and
financial cases for the Plan, bind all the foregoing Sections more fully together, and while at it
flesh out their full human and economic significance “on the ground.”
The first thing to note “on the ground,” then, is the great rise in home vacancy rates in
states hit most hard by the mortgage foreclosure crisis to date. U.S. Census Bureau data
indicate that nonseasonal vacant properties have increased 51% nationally from under 7 million
in 2000 to over 10 million in early 2010. 153 Ten states in particular – including California, in
keeping with our case study methodology – saw increases of 70% or more. 154 Other “sunbelt”
and “sand” states – Arizona, Nevada, and Florida, for example – saw these larger increases as
well. The overwhelmingly greater part of the spike in all places, moreover, has occurred since
2006, when the bubble peaked and then plunged.155

153

See Government Accountability Office, Vacant Properties: Growing Number Increases Communities’ Costs
and Challenges, Report to the Ranking Member, Subcommittee on Regulatory Affairs, Stimulus Oversight, and
Government Spending, Committee on Oversight and Government Reform, House of Representatives, November
2011 (hereinafter “GAO Report”). Also Federal Reserve Board, supra note 8; Dudley, supra note 8; and Alpert,
Hockett, & Roubini, The Way Forward, supra note 22.
154
GAO Report, id.
155
Id.

49

Unsurprisingly, high foreclosure rates closely correlate with the growing vacancy rates
in question, accounting in many cases for as much as three-fourths of the increase. 156 So too,
then, do high underwater mortgage rates, since these themselves correlate overwhelmingly
with foreclosures as noted above in Sections I and II. 157 This is not only because people
ultimately leave foreclosed homes. It is also because the foreclosure process itself is a drawn
out affair, meaning that foreclosers are unable to place properties back on the market quickly
even where there might be demand. 158 As it happens, however, there is little demand either –
another source of the spike in vacancy rates. 159 All in all, then, these factors slow the rate at
which homes that are left come to be reoccupied, which of course adds up to spiking vacancy
rates.
Associated unemployment, in some cases responsible for foreclosures themselves while
in other cases attendant on economic slump that both reinforces and is reinforced by mass
foreclosure, is another source of spiking vacancy rates. 160 A tertiary cause appears to be
migration from hard hit cities that is itself a response to declining employment opportunities
which themselves interact symbiotically with foreclosure rates per the feedback effects
discussed above throughout Sections I and II. 161 There are straightforward feedback effects
between these phenomena and spiking vacancy rates. 162
Growing home vacancy rates of course represent considerable individual and familial
trauma. Involuntarily uprooted families are at least temporarily deprived of the most basic of
human needs – the need of shelter, a “home base,” a place to conduct stable family life. There
are countless studies documenting the incalculable psychological and physical toll on children,
in particular, wrought by foreclosure and eviction. 163 The toll taken on adults is immense as
well. As a qualitative matter, this all perhaps goes without saying. As a quantitative matter, a
70% spike in home vacancy rates is of course much more than a 70% spike in rates of the
mentioned traumas. For prior to the spike, what vacancies there are will be less the result of
foreclosure than they are or regular economically induced migration.

156

See sources supra, note 153.
See supra, Sections I and II, and sources there cited.
158
See notes 156 and 157.
159
GAO Report, supra note 153.
160
See sources cited supra, note 153, as well as supra, Sections I and II and sources cited therein.
161
GAO Report, supra note 153.
162
Id.
163
See, e.g., Janet Currie & Erdal Tekin, Is the Foreclosure Crisis Making Us Sick?, NBER Working Paper No.
17310, August 2011, available at http://www.nber.org/papers/w17310; G.T. Kingsley et al., The Impacts of
Foreclosures on Families and Communities, White Paper, The Urban Institute, May, 2009, available at
http://www.urban.org/UploadedPDF/411909_impact_of_forclosures.pdf.
157

50

Growing home vacancy rates also impose great pecuniary and other costs upon
municipalities.164 Although most if not all counties have on their books legal requirements that
owners before and after foreclosure maintain their properties, as a practical matter this doesn’t
tend to happen.165 Parties on either end of foreclosures have other things on their minds: The
foreclosed party, where to go next; the foreclosing party, how in heaven’s name to process all
the remaining foreclosures that impend.
The consequence is that municipalities themselves must maintain or demolish the
properties in question. 166 Simply boarding up abandoned properties typically costs hundreds to
thousands of dollars per structure.167 Cutting grass, draining swimming pools, or removing
debris entails similar costs, some of them repeated regularly for each property.168 Demolition
ultimately proves necessary for many properties, and entails costs well into the thousands of
dollars – even double digit thousands – for each property demolished.169 Some of these costs
are occasioned by the physical process itself, others by the administrative and judicial
requirements that have to be met before absentee mortgagee-owned property can be simply
destroyed. 170
Before abandoned properties are properly sealed off or demolished, they also impose
significant safety costs on communities. 171 Many of them act as “attractive nuisances,” to
employ the familiar tort law term, to minors and others. Others attract criminals and crime,
including not only drug-dealing and prostitution, but materials-stripping, vandalism and
arson. 172 These represent not only costs in themselves, but also costs in the form of increased
law enforcement expenditure on the part of affected municipalities.
Abandoned properties also, of course – partly in virtue of the tendencies just noted but
also of themselves – reduce the value of surrounding properties, often thus leading to further
desertion and migration: yet another self-worsening feedback or “snowball” effect once a
critical mass of abandoned properties is reached.173 The numbers are often impressive. One

164
165
166
167
168
169
170
171
172
173

See sources cited supra, notes 153 and 163.
GAO Report, supra note 153.
Id.
Id.
Id.
See sources cited supra, notes 153 and 163.
GAO Report, supra note 153.
See sources cited supra, notes 153 and 163.
Id.
See sources cited supra, notes 153 and 163.

51

study has found that even a single foreclosed home depresses prices of nearby homes from just
under one to as high as 8.7 percent.174
Again, this is just one foreclosed home. Another study found that one demolished
home reduced the values of 13 surrounding properties by $17,000 per.175 Yet another study
found that a single foreclosed, vacant home reduces the value of neighboring properties by 10
percent, and all homes within 500 feet of it by an average of .7%. 176 One could proliferate
references to studies of this sort with abandon,177 but the point is presumably made, and is at
all events hardly surprising.
Also hardly surprising is that all of this foreclosure, abandonment, and consequent value
loss results in municipal revenue loss. 178 Municipalities in America overwhelmingly finance
their operations through property tax assessments. 179 Lose property dwellers, lose property
values, and you lose funding – all while needing more such funding to handle the costs wrought
by the abandoned homes themselves as elaborated above. And this is so notwithstanding loan
servicers’ being required to keep up property tax payments during foreclosure proceedings. 180
Of course, some federal programs are aimed at assisting hard hit localities in handling
the growing costs despite dwindling revenues. 181 But these do not appear to be functioning
well and in any event simply represent shifts of the costs to the federal budget, rather than
eliminating the source of those costs.182 Why on earth would this be preferred to
municipalities’ taking charge of and reversing their own declines on behalf of their citizens by
pursuing the Municipal Plan sketched in Section III?
The costs run through thus far all are attendant on actual foreclosure and actual
vacancy. But there are additional costs wrought by what might be called “shadow” vacancy, if
one might be forgiven for coining another neologism. 183 Here we refer to the much lower

174
175
176
177
178
179
180
181
182
183

GAO Report, supra note 153.
Id.
Id.
They are cited with abandon (pun intended) in the GAO Report, supra note 153.
See sources cited supra, notes 153 and 163.
Id.
GAO Report, supra note 153.
As discussed supra, Section II.
Id.
By analogy to “shadow inventory” and “shadow banking.”

52

investments of moneys and labor in home improvement or home maintenance that
underwater mortgagors make. 184
The reasons are not hard to find. For one thing these mortgagors, strapped as they are,
are apt to be out of the house more either working extra hours or seeking such work. For
another thing, insofar as their underwater status induces uncertainty concerning how much
longer they are likely to be able to hold on, it likewise induces a search for alternative residence
and livelihood.
Finally, of course, it would simply not seem to be consistent with “human nature” to
invest one’s care and concern in a home that one senses s/he might very soon lose. For all of
these reasons, underwater mortgaged homes deteriorate much more rapidly than do other
homes even well before foreclosure. These homes are in a certain sense “vacant already,” in
that the owners in many cases will have psychologically detached themselves from them.
Heightened degrees of this same form of detachment of course bring on “walkaway” and
“strategic default” in some cases. It is, after all, financially rational to default on an underwater
mortgage, since one thereby “pays” with the lower-valued asset rather than the higher-valued
principal amount. 185
This of course leads straight to the costs that foreclosure and “shadow” foreclosure
impose upon lenders themselves. Lenders naturally are well aware of these costs, and for that
very reason are apt to favor principal writedowns. The problem is that they cannot coordinate
to secure them, for reasons comprehensively adduced above in Section II. Insofar as some of
these lenders themselves reside in the municipalities in question, counties that exercise their
eminent domain authority pursuant to the Municipal Plan act authoritatively on their behalves
too. And this is of course not to mention the sense in which these municipalities will act
collaterally, in effect, to the benefit of all others who wish to see principal writedowns as well.
All of the foregoing are widely appreciated, well documented and well quantified
tendencies nationwide in the midst of our ongoing and self-worsening mortgage foreclosure
crisis. All of them likewise serve to underwrite an obvious and indeed exigent public purpose
on the basis of which municipalities can exercise their traditional eminent domain authority
pursuant to the Plan that is the subject of this Memorandum. To sharpen things once more
184

See sources cited supra, notes 153 and 163. Also Goodman, sources cited supra, note 61; and Brian T.
Meltzer, Mortgage Debt Overhang: Reduced Investment by Homeowners with Negative Equity (August 2010)
(working paper, on file with the author).
185
Indeed, “efficient breach” theories of contract reneging such as have proliferated in conservative, “law
and economics” approaches to contract in such schools as the University of Chicago have it that forgoing strategic
default is irrational.

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with a specific case study, however, it might be well also to supply some of the applicable
numbers for our previously selected illustrative sample state, California, and our sample county
therein, San Bernardino.186 Here are a few of the numbers in question.187

Conclusion: What’s Next
We have covered a good bit of ground here. But much more remains to be done.
Presumably the financial and legal cases for municipalities’ and cognate authorities’ embracing
and acting upon plans like the Municipal Plan have been fully made. What remains is for
specific municipalities now to begin doing so. That is apt to begin very soon. For there are
financial planners and investor coalitions ready to begin partnering with the hardest hit
counties. Once these counties and their private partners commence proceedings, and once
they start succeeding, and once word gets out, others will surely be quick to follow. For it is the
solution that all of them have quite literally been waiting for.
In closing, perhaps the following observation will be in order. “We” might not have
turned out to be “the ones we’ve been waiting for” if the “we” in question is our presently
“operationally challenged” federal government. But “we” indeed are the ones we’ve been
waiting for if “we” be our own towns and neighborhoods – if “we” be “the people” in that much
more concrete and visceral, rather than diffuse and abstract, sense that a great observer of
American life once suggested. The observer in question was Alexis de Tocqueville, who said, in
effect – well before a quotable former First Lady did – that in America, it takes a village. It
would seem he was right.

186

For reminder of why San Bernardino, California makes for an illustrative case study, please see supra, note
54, and accompanying text.
187
Figures forthcoming.

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Technical Appendix A: Mortgage Selection and Fair Valuation Methodologies

Technical Appendix B: Further Jurisdictional and Other Legal Details

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