What are these CA Officials Thinking?

Today (7/13/12) it was reported that officials in San Bernardino County (CA) have been in secret talks as to whether or not to use the power of eminent domain to seize troubled mortgages from banks.   

 http://www.reuters.com/article/2012/07/13/us-sanbernardino-eminentdomain-idUSBRE86C14K20120713

California has been one of the hardest states hit by the financial crisis, and as a result has one of the highest rates of underwater mortgages in the country.  For those of you who don’t know, being “underwater” on your mortgage means you currently owe more on your mortgage than what your home is worth.

I have one question for the officials in San Bernardino County.  Is it your intention to put the final nail in the coffin of the state of California?  Maybe the officials in California truly believe they are doing the right thing, but the road to hell is paved with good intentions.  Or are they just doing this to show they are doing something, anything, in hopes of getting re-elected.  It is obvious that fiscally they have ran their county into the abyss, so this may be the “Hail Mary” of their re-election efforts.

Details are still to follow on how this would play out.  But here is what is most likely to happen here.  Banks are currently holding onto these mortgages that are underwater, hoping for two things.  Either the government comes in with QE 3 (quantitative easing… or money printing) and purchasing mortgage backed securities which will help get these under-performing mortgages off the bank’s balance sheet and onto the federal reserve’s (or in other words… the taxpayers), or the U.S. Congress comes in with some sort of bailout for the banks.  This is why the banks have been for the most part unwilling to help out these underwater homeowners.  If there was an actual free market, where the government didn’t pick and choose who they were going to bailout, the banks would have started working with underwater homeowners a long time ago. It would be in the banks best interests to do so in order to minimize the losses on that under-performing mortgage.

So while the banks are waiting on either the Fed or action from Congress, the officials in the County of San Bernardino have decided to take matters into their own hands.  They are going to force the banks to give these mortgages to the County.  The county then will lower the outstanding mortgage to the homes current market value.  This could literally knock off 100k or more in debt on that home in some circumstances.  The question remains… who is going to be on the hook for that loss?  It’s either going to be the bank or the county.  Since the county of San Bernardino is broke along with most counties in California, it is certain the county will force the banks to take this loss. 

On the surface this doesn’t seem like a bad idea right?  The homeowner is no longer underwater; this gives them the ability to refinance to today’s record low mortgage rates.  Now the homeowner also has more discretionary income that could be used to help support the California economy.  Seems all well and good right?  Wrong!

The unintended consequences would be disastrous for California.  These banks that had these mortgages “stolen” from them now have to write down these gigantic losses on their balance sheets.  Banks still have not recovered from the financial crisis.  This giant blow to their financial standing would send bank stocks plummeting as analysts scramble to figure out how big of a blow this will have on bank earnings.  I’m sure at this point you’re thinking… who cares?  The banks deserve to have their stock prices collapse.  Fair enough.

But the biggest unintended consequence would be banks no longer willing to write mortgages in the state of California.  Or at least they will raise interest rates dramatically.  Who can blame them?  Just like with the bankruptcy of the auto companies, contractual law has been thrown out the window by an iron-fisted government.  We look more like Soviet Russia at this point than the “land of the free and home of the brave.” 

With banks refusing to lend, or at a minimum higher mortgage rates in the state of California, housing prices would go into free fall.  The rest of the country also wouldn’t be immune from falling housing prices.  Banks would start to demand higher interest rates on mortgages everywhere in the U.S. as they start to determine the likelihood that counties in other states contemplate using eminent domain as well.  Higher mortgage rates mean’s higher mortgage payments.  This means potential buyers will have to lower the amount they can borrower in order to be able to afford the payments.  The result is sellers having to come down on the asking price.  This is bad news all around.

We all know the saying, that what happens in California tends to make its way into other states.  This is one of those times where I hope, “what happens in California, stays in California.”