Around the Web: The Failure of Detroit and the Demagogue of Vienna

  1. Ilya Somin argues that Detroit’s aggressive use of eminent domain needs to be incorporated into any discussion of Detroit’s failure (be sure to read through the ‘comments’ section, too).
  2. Richard Wolff blames “capitalism” for Detroit’s failure. No seriously.
  3. Historian Andrei Znamenski has a great piece in the Independent Review on the political life of Karl Lueger, a socialist who became mayor of Vienna in the late 19th century.

Ultimately, I think that Detroit’s failure can be chalked up to bad fiscal policy, cronyism (at the local, regional and federal levels) and freer trade (which lets me drive a high-quality Toyota rather than some clunker from Detroit).

Lueger was an advocate of social justice and consequently of national socialism. Znamenski found that he had a profound influence on the thinking of an impressionable young artist living in Vienna at the time.

An Ominous Expansion of Eminent Domain

A new assault on private property is in the works and it hasn’t gotten much attention – yet.  Needless to say, it goes by an Orwellian name, in this case the “Homeownership Protection Act.”  As summarized recently by Kathleen Pender in the San Francisco Chronicle, the scheme has been hatched by two cities in San Bernardino County and has not taken effect yet but is under serious consideration.  A new agency called a “Joint Powers Agreement” would be formed to do the dirty work.

The idea is to use the power of eminent domain to seize mortgages – not houses but mortgages owed to lenders by homeowners who have defaulted or are under water.  Using Ms. Pender’s example, suppose there is a $300,000 mortgage on a house worth $200,000.  The agency decides the mortgage balance should be $190,000 which would leave the homeowner with $10,000 in equity.  It seizes the mortgage and compensates the mortgage holder in an amount such as $170,000.  A new mortgage in the amount of $190,000 is then issued by a private firm which would reimburse the agency some lesser amount, say $180,000.  Thus the private firm pockets $10,000 up front and the agency another $10,000. One such firm, Mortgage Resolution Partners, has already been formed in San Francisco for this purpose.

There are some technical questions.  How is the house value determined?  By appraisers, presumably, but we saw in the housing bubble how useless their numbers were.  And what if the mortgage had been securitized, i.e., put into a mortgage-backed security?  The Federal Reserve holds a lot of these securities.  What if a local government entity tried to seize a mortgage that was ultimately owned by the Fed?  Wouldn’t that be fun?

Technical questions aside, the whole idea portends a massive new assault on private property by ravenous politicians and bureaucrats and their private co-conspirators.

Eminent domain has generally been understood as a way of solving holdout problems when a “public” project is proposed.  Such projects typically require acquisition of property from a number of owners and can’t be built at all unless and until all owners are willing to sell.  A single holdout can ruin the project.  Thus eminent domain has almost always been used to seize real property (land and buildings) as opposed to personal property such as mortgages.  (Private solutions to holdout problems have been proposed.)

The only ultimate limitation on the use of eminent domain is a clause in the Fifth Amendment to the U.S. Constitution which says “nor shall private property be taken for public use without just compensation.”  That clause is of course wide open to varying interpretations of “public use” and “just compensation.”

A landmark Supreme Court 5-4 decision in 2005 held that the City of New London could seize a modest house owned by Suzette Kelo and hand it over to a private developer.  The house and surrounding buildings were seized and destroyed but the project went bust and the land is still vacant.  This was a significant extension of the notion of “public use.”  Justice Stevens in his decision to uphold the City noted that “a public purpose will often benefit individual private parties.”

Indeed.  Can there ever be a public project that does not benefit some private party?  Any public project necessarily diverts resources to some private party such as a contractor or neighbors whose property values are enhanced.  Turning the proposition around, almost any private project throws off some public benefits.  Kelo opened the door to conspiracies of private developers and public officials to launch almost any sort of assault on anyone’s private property.

The “just compensation” clause is also gravely problematic.  Suzette Kelo loved her little pink house.  Its market value wasn’t nearly enough to compensate for the emotional loss she suffered when she was kicked out.  Values, as distinct from prices, are subjective and are revealed by voluntary transactions.

In addition to the obvious grave immorality of this latest assault on private property, consider the incentive problems that it raises.  Future savers will be reluctant to invest their savings in mortgages or financial products containing mortgages knowing they could be expropriated.  Homeowners will find loans harder to get, thanks to the “Homeowner Protection Act.”  (Echoes of Ludwig von Mises: government interventions invariably make things worse for their ostensible beneficiaries.) There will be a marginal shift away from saving toward consumption.  Economic growth will be marginally slowed, for which politicians will blame the free market and plump for yet more expansions of government power.

Should the San Bernardino project go forward, it will be very likely to end up at the Supreme Court.  The Kelo and Obamacare decisions do not bode well for the result.