Eminent Domain and Fair Market Value in a Depressed Real Estate Market (2014)

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4 responses are discussed throughout the digest and summarized in Appendix B. II. EFFECT OF THE FINANCIAL CRISIS ON PROPERTY VALUES, FINANCIAL INSTITUTIONS, PROPERTY OWNERS, AND TRANSPORTATION DEPARTMENTS A. The Emergence and Scope of the Financial Crisis In late 2006 housing sales and property values began to decline significantly and the number of loan defaults and foreclosures began to increase.5 In the summer of 2007, a liquidity crisis developed when investors began to doubt the value of financial instruments securitized by real estate; when the Federal Deposit Insurance Corporation (FDIC) exposed unsound lending practices; and when some investment banks and houses closed or appeared to be on the verge of doing so.6 The disappearance of liquid capital caused banks that had been relying on short-term borrowing to incur excessive costs when attempting to roll over their liabilities.7 In June 2007 the financial markets in the United States spiraled downward rapidly with the collapse of Bear Sterns hedge funds followed by a 2-week period in September 2008 when six major financial institutions in the United States began to fail.8 When Lehman Brothers (Lehman) appeared to be on the brink of filing for bankruptcy, the Treasury Department and the Federal Reserve developed a plan to enable Lehman to transfer net assets to Barclays Bank in the United Kingdom.9 A stalemate developed when Lehman was unable and the Federal Reserve was unwilling to guarantee Lehman’s Michigan DOT; Oregon DOT; Utah DOT; and Wiscon- sin DOT. 5 Senate Report on the Financial Crisis, supra note 3, at 45. 6 MARTIN NEIL BAILY AND DOUGLAS J. ELLIOTT, INITIATIVE ON BUS. & PUB. POLICY AT BROOKINGS, THE US FINANCIAL AND ECONOMIC CRISIS: WHERE DOES IT STAND AND WHERE DO WE GO FROM HERE?, at 5 (2009), hereinafter referred to as “Baily and Elliott,” available at http://www.brookings.edu/research/papers/2009/06/15- economic-crisis-baily-elliott. 7 Id. at 5. See also Senate Report on the Financial Crisis, supra note 3, at 45, 46. 8 Senate Report on the Financial Crisis, supra note 3, at 45. 9 Ciro, supra note 1, at 40. obligations until the sales transaction was complete. The Financial Services Authority in the United Kingdom refused to approve the agreement between Barclays and Lehman.10 In September 2008, Lehman filed for the largest corporate bankruptcy in United States history.11 According to a report by the United States Senate’s Homeland Security and Government Affairs Committee, a primary cause of the crisis was the downgrading in July 2007 by two ratings agencies, Moody’s and Standard & Poor’s, of hundreds of collateralized debt obligations (CDO) and residential mortgage-backed securities.12 Because of the steady rise in home values in the United States, Americans had taken on an increasing amount of debt in the form of household mortgages that were repackaged and sold to investors as CDOs.13 The downgrading of these financial instruments was said to be a result of unsound and predatory lending practices followed by a record number of loan defaults and foreclosures on mortgaged properties.14 The effects of the financial crisis, decline in real property values, and increase in unemployment reverberated throughout the economy. The first quarter of 2009 saw gross domestic product decrease by 6.4 percent (after decreasing by 5.4 percent in the last quarter of 2008), which was the lowest level of economic growth in a 6-month period since 1958.15 In February 2009, one index of consumer confidence fell to an all-time low of 25.16 B. The Effect on Real Property Values With respect to property values, by the first quarter of 2009, housing prices in the United States had declined to 68 percent of their peak 10 Baily and Elliott, supra note 6, at 5; Ciro, supra note 1, at 40–41 (citing H.M. PAULSON, ON THE BRINK: INSIDE THE RACE TO STOP THE COLLAPSE OF THE GLOBAL FINANCIAL SYSTEM 335 n. 5 (2010)). 11 Ciro, supra note 1, at 40–41. 12 Senate Report on the Financial Crisis, supra note 3, at 6 and 45. 13 Ciro, supra note 1, at 33. 14 FEDERAL DEPOSIT INSURANCE CORPORATION, FINANCIAL INSTITUTION LETTER, PREDATORY LENDING, at 1 (2007), available at http://www.fdic.gov/news/news/ financial/2007/fil07006.pdf. 15 PHILLIP SWAGEL, PEW FINANCIAL REFORM PROJECT, THE COST OF THE FINANCIAL CRISIS: THE IMPACT OF THE SEPTEMBER 2008 ECONOMIC COLLAPSE, at 8 (2008), hereinafter referred to as “Swagel.” 16 Baily and Elliott, supra note 6, at 4.

5 values recorded in the second quarter of 2006.17 The decline in the value of residential property from mid-2007 to March 2009 was an estimated $5.9 trillion.18 Housing values that had peaked in the first quarter of 2006 finally reached bottom by the first quarter of 2012 at about 57 percent of their peak values. 19 By the fourth quarter of 2012, housing values had recovered only to around 62 percent of their 2006 highs.20 In the fourth quarter of 2009, at the apex of the financial crisis, approximately 24 percent or 11.3 million home mortgages were “underwater;”21 that is, the values of properties were less than the outstanding balances of the mortgages secured by the properties. By the first quarter of 2013, approximately 20 percent or 9.7 million of all residential homes with a mortgage were still underwater.22 Before the financial crisis, on average 21,000 foreclosures were completed each month between 2000 and 2006.23 By April 2013, approximately 52,000 properties were being foreclosed.24 However, April 2013 also was the 18th consecutive month in which there was a year-to-year decline in the inventory of foreclosures; for example, the number of 17 Location, Location, Location, THE ECONOMIST (May 16, 2013, updated Aug. 29, 2014) (unnumbered pages), hereinafter referred to as “Economist Article,” updated version available at: http://www.economist.com/ blogs/dailychart/2011/11/global-house-prices. 18 Swagel, supra note 15, at 13. 19 Economist Article, supra note 17 (unnumbered page). 20 Id. 21 Vi Ransel, Global Research, Social Inequality in America: Widening Income Disparities, Workhouse Na- tion: Part One (March 24, 2010), available at http://www.globalresearch.ca/social-inequality-in- america-widening-income-disparities/18281 (quoting First American CoreLogic). 22 Matt Egan, 850K Underwater Mortgages Finally Gasp for Air in 1Q, FOX BUSINESS (June 12, 2013), here- inafter referred to as “Egan,” (citing CoreLogic), avail- able at http://www.foxbusiness.com/markets/2013/06/ 12/underwater-mortgage-percentage-falls-below-20/. 23 Christine DiGangi, Credit.com, Seriously Delin- quent Mortgages Hit 5-Year Low (Jan. 13, 2014), available at http://blog.credit.com/2014/01/ seriously-delinquent-mortgages-hit-5-year-low-73632/. 24 Mark Huffman, Consumer Affairs, Foreclosure Rates and Mortgage Delinquencies (Sept. 12, 2014), available at http://www.consumeraffairs.com/ foreclosure-rates-and-mortgage-delinquencies. foreclosures between April 2012 and April 2013 declined by 24 percent.25 C. The Effect on Financial Institutions At the outset of the crisis, banks that previously were able to rely on short-term borrowing when needed to roll over their liabilities were no longer able to depend on this source of capital.26 As the crisis deepened, financial institutions had to write-off substantial amounts in losses based on non-performing loans and the reduced value of assets from subprime loans and other high-risk lines of credit.27 For example, the International Monetary Fund (IMF) estimated that the total value of write-downs on assets originating from the United States after the crisis was $2.7 trillion out of a total value of $27 trillion of all assets originating in the United States.28 Increases in loan defaults and foreclosures can have a seriously negative effect on financial institutions because of the costs of the foreclosure process and the difference between sales prices of properties and their mortgage balances.29 Financial institutions lose money on foreclosures when the sales price of a property is less than the balance of the mortgage on the property plus transaction costs and fees.30 During the financial crisis, losses on foreclosed properties were enhanced by the fact that financial institutions had originated almost 30 percent of all home loans in 2007 without a down payment.31 25 John Krainer, Federal Reserve Bank of San Fran- cisco, The Slowdown in Existing Home Sales (May 19, 2014), available at http://www.frbsf.org/economic- research/publications/economic-letter/2014/may/ existing-home-sales-slowdown/. 26 Baily and Elliott, supra note 6, at 5. See also Sen- ate Report on the Financial Crisis, supra note 3, at 5. 27 CONGRESSIONAL BUDGET OFFICE, BUDGET AND ECONOMIC OUTLOOK: AN UPDATE 27 (Sept. 2008), here- inafter referred to as “CBO Budget and Economic Out- look,” available at http://www.cbo.gov/publication/ 41729, at 27. 28 INTERNATIONAL MONETARY FUND, FURTHER ACTION NEEDED TO REINFORCE SIGNS OF MARKET RECOVERY (Apr. 2009), available at http://www.imf.org/external/ pubs/ft/survey/so/2009/RES042109C.htm. 29 U.S. GOV’T ACCOUNTABILITY OFFICE, FINANCIAL REGULATORY REFORM: FINANCIAL CRISIS LOSSES AND POTENTIAL IMPACTS OF THE DODD-FRANK ACT 24 (2013), hereinafter referred to as “GAO Report on Financial Regulatory Reform.” 30 Id. 31 Rachel D. Godsil and David V. Simunovich, Pro- tecting Status: The Mortgage Crisis, Eminent Domain,

6 Financial institutions suffer losses when governments condemn properties having under- water-mortgages. When a government takes a mortgaged property by eminent domain, the mortgagee (i.e., the lender or financial institution) receives the money paid for the property up to the outstanding balance of the mortgage.32 Moreover, the mortgagee may lose any prepayment fees if they were required by the loan documents.33 Regardless of whether a condemnation award is sufficient to pay the mortgage on the property taken, a mortgagee forfeits its anticipated financial gain because of the prepayment of the loan and the loss of future revenue.34 D. The Effect on Property Owners During the financial crisis, financial institutions and homeowners had both interrelated interests and divergent interests. Property owners who were shareholders in financial institutions were affected by the declining value of the shares of the institutions, as well as by a reduction in dividends payable on the institutions’ shares or by the institutions’ suspension of their dividend payments. Furthermore, as a result of the crisis, banks were required to increase lending standards and restrictions on loans for residential property, thus affecting sellers whose purchasers needed a mortgage to be able to buy property that was for sale. New lending standards and restrictions also affected business owners needing capital.35 The decline in the availability of credit impaired if not precluded some homeowners’ and business owners’ ability to pay expenses.36 The financial crisis led to increased unemployment, thus making it more difficult or impossible for some property owners to make their mortgage payments.37 Many homeowners who were unable to sell their homes ultimately lost their homes to and the Ethic of Homeownership, 77 FORDHAM L. REV. 949 at 960 (2008), hereinafter referred to as “Godsil and Simunovich.” 32 Dale A. Whitman, Mortgage Prepayment Clauses: An Economic and Legal Analysis, 40 UCLA L. REV. 851, 913 (1992), hereinafter referred to as “Whitman.” 33 Id. at 914. 34 Id. at 915. 35 CBO Budget and Economic Outlook, supra note 27, at 29. 36 Id. 37 GAO Report on Financial Regulatory Reform, supra note 29, at 23. foreclosure, resulting in a loss of equity, if any, in their property and in lower credit scores that would affect their ability to qualify for a loan in the future.38 Foreclosures and vacant properties depressed even further the value of other properties in the area.39 During the financial crisis, by the time of a taking of a property, the value of some properties that were purchased at the onset of the financial crisis was less than the properties’ purchase price and frequently less than the balance of a mortgage on the properties. As discussed in the digest, when a homeowner’s property is taken in eminent domain the homeowner may be unable to find another home elsewhere that is affordable,40 particularly when the value of the property taken was less than the balance of the mortgage on the property. Although a financial institution backing a mortgage loses its security interest when the government takes property serving as collateral, typically any remaining amount due on the mortgage plus expenses and fees continue to be the obligation of the borrower, i.e., the mortgagor.41 E. The Effect on Transportation Departments The financial crisis significantly affected state governments and their transportation departments. Similar to financial institutions and property owners, declining property values and an increase in foreclosures created a financial burden on state and local governments because of decreased property tax revenue and the costs associated with vacant properties.42 For example, state tax revenues had decreased by 8.4 percent in 2009 from the previous year, and the aggregate budgetary deficit of all states was almost $200 billion in 2010.43 Therefore, state governments had to slash spending, including spending on transportation projects.44 38 Id. at 24. 39 Id. 40 Godsil and Simunovich, supra note 31, at 968. 41 Whitman, supra note 32, at 915. 42 GAO Report on Financial Regulatory Reform, su- pra note 29, at 24. 43 John Hood, The States in Crisis, NATIONAL AFFAIRS, Winter 2011, at 51, available at: http://www.nationalaffairs.com/publications/detail/the- states-in-crisis. 44 Cathy Proctor, FasTrack Costs Have Dropped, But So Have Funds for Project, RTD Says, DENVER BUSINESS JOURNAL, Jan. 5, 2010, hereinafter referred to as “Proctor,” available at http://www.bizjournals.com/