A new report by Cornell Law Professor Robert Hockett published in the Federal Reserve Bank of New York's Current Issues in Economics and Finance is renewing debate over the merits of his 'Municipal Plan' to reduce mortgage debt, revive housing markets, and thereby aid creditors, debtors, their communities, and the national economy.
According to the report, many of the nation's approximately 11 million underwater home loans are needlessly undervalued because significant negative equity brings high default and foreclosure risk.
"This means that write-downs in some cases will raise value, which is good for investors, homeowners, their communities and the broader economy alike," says Hockett. "The problem is that a host of classic creditor collective action problems, reinforced by the terms of some bubble-era securitization contracts, prevent write-downs on the requisite scale in the case of some private label securitizations."
Solution of these collective action problems, says Hockett, requires a collective agent—a role that additional structural barriers prevent many trustees and loan servicers from playing. Hockett concludes that state and local governments are optimally situated to facilitate or 'mimic' workouts between creditors and debtors by using their eminent domain authority to sidestep problematic securitization arrangements. "In so doing, they will be curing a cluster of classic market failures, recouping presently lost value, and positioning themselves to distribute that value equitably among all stakeholders," says Hockett. "A combination of federal, nonprofit, and private—including current bondholder—moneys can be used to finance the purchases."
While Hockett first proposed action of this kind and related kinds during the early years of the crisis—first as an optimal use for TARP moneys—it is only in the last two years that local governments, foundations, and other private entities have begun seriously considering the idea. Since then Hockett has advised multiple state and city governments, community and housing advocacy groups, and both nonprofit and for-profit private entities on the financial merits and legal propriety of the plan. (While one private entity, MRP, founded by an old friend and fellow Rhodes scholar of Hockett's, paid him a nominal fee for a legal analysis early in 2012, since that time all of his work on the plan has been gratis.)
Last summer, Yale economist Robert J. Shiller endorsed Hockett's approach. Hockett adds, "The New York Fed report is another indicator of broadening recognition that this kind of plan is worthy of careful discussion, even while other FRBNY reports, like that published in February on its Liberty Street Economics blog, counsel disciplined cost-benefit analysis of any such plan.”