Arizona’s SB 1451 – Does Arizona Have the Right to Save Itself from Drowning in Underwater Loans?

Drowning in the desert.  The irony alone could kill you.

Arizona’s Senator Michele Reagan (R-Scottsdale) is a very courageous politician.  This year she has introduced SB 1451, the “Housing Finance Reform Act of 2012,” a bill that would solve the state’s negative equity problem by providing homeowners that are current on their mortgages, with a way to refinance their loans at or near current market value…. without costing the state a nickel.


If SB 1451 were to become state law, Arizona’s homeowners would no longer be dependent on the federal government, through Fannie Mae, Freddie Mac or FHA, to refinance their mortgages.  The bill would make it possible for up to 90 percent of Arizona’s homeowners to refinance their existing loans, lowering their current monthly payments by a third, and reducing their principal balances to amounts at or near today’s market value.


Can you imagine the immediate impact on Arizona’s economy, even if only if 50 percent of the state’s homeowners were paying a third less each month than they’re paying now, and were no longer hopelessly underwater?


Consumer spending in Arizona would increase almost overnight as homeowners once again would view their homes as valued assets, instead of as depreciating liabilities.  It’s not hard to imagine that the home improvement market would be among the first to spring to life as homeowners re-started projects delayed during the prolonged downturn in home prices and the broader economy, and that sort of spending means immediate jobs for tens of thousands of Arizonans.


What’s not to love?

As incredible as it may seem, there are a few in Arizona that oppose SB 1451.  Included in that group is well-known columnist at The Arizona Republic, Robert Robb, who wrote a piece about the bill this past week in which he claimed its consequences to be “devastating.”


Devastating?  Seriously?


Let’s just re-cap for a moment to make sure we’re all on the same page… SB 1451 allows for the refinancing of current mortgages at or near today’s market value, it reduces each homeowner’s monthly payment by at least one-third, it means that Arizona’s homeowners would no longer be dependent on the federal government every time they wanted a mortgage, it creates thousands of jobs faster than you can say… remodel my bathroom, and it doesn’t cost the state or its taxpayers a nickel.


Which part could possibly be thought of as devastating, do you suppose?  Would it be the prosperity breaking out all over the state like the desert in bloom that Robb finds objectionable?



Robb’s argument against SB 1451 begins with his claim that it violates the state’s constitution, which frankly I found quite amusing for several reasons.


For one thing, in his article, the words “Arizona Constitution,” appear in light blue, like it’s a link to a clause in the state’s constitution prohibiting something that the bill does, thus supporting his claim that the bill is unconstitutional.  But, when you click on the link you jump to a page of past stories ABOUT the Arizona constitution, only one of which has anything to do with SB 1451, and wouldn’t you know it… it’s Robb’s article… the same one you just clicked out of to begin your circular journey.  Robb claims the bill is unconstitutional and then he sources himself making the same claim about constitutionality.  So, very well done indeed.  Perhaps later he’ll quote himself.


The other reason the constitutionality argument seems frivolous to me is that Robb raises it as an issue at the beginning in his piece about the bill, and it just seems to me that if he actually thought his point was correct, he wouldn’t have needed to bother writing the rest of his article.  I mean… why worry about a bill passing if it’s only going to create an unconstitutional state law, right?  There’s no danger of devastation occurring there, is there?


Seems like, even if the bill passed, the Governor would take one look, say… “Sorry, can’t sign it … it’s unconstitutional,” and then we could all go back to contemplating the timing of our respective strategic defaults on our underwater mortgages.


As one might imagine, however, Senator Reagan, with ten years in the Arizona legislature, did consider the constitutionality issue during the 10 months she was working with her legislative team on the state program and the bill’s language… you know… before she presented it to Mr. Robb and he so cleverly raised it, and so she’s quite comfortable with her bill’s constitutionality… or would that be constitutional conformity?  Constitutionosity?


No matter, in my mind it’s really a question for the legal scholars anyway, isn’t it?  And Robb may think it going out on a limb, but I for one have complete confidence that the State of Arizona will be able to figure out what its own constitution does and does not allow.  And if it turns out that it’s okay with the state, well, then I’d have to say that it’s okay with me.


I did manage to check with two, by the way… legal scholars, I mean… unlike Reporter Robb I make it a rule never to source myself in public… and both said that it was constitutional and explained why they thought so.


(There was a third legal scholar that I’m pretty sure also agreed that it was constitutional, but honestly, I must have dozed off during his riveting 40-minute dissertation on all-things-constitutional that at one point was explaining something about due process originating with Egyptian kings.  Luckily, I woke up just in time to thank him for his very thorough response and say goodbye.)


Robb says, at least in part, that SB 1451 is unconstitutional because it breaks the terms of existing contracts.  But the first legal scholar responded to Robb’s claim by saying: “The law is clear: The right of the state to take private property supersedes private contracts.”  See West River Bridge v. Dix, 47 U.S.C. 507 (1848) and its progeny; see also Home Building & Loan Association v. Blaisdell 290 U.S. 398 (1934).  He also explained…


“Government taking of property has been part our laws for over 200 years.  The basic requirements for such a taking are a clear public policy and payment of just compensation.  In this case the public policy is undeniable – addressing the state’s economic and fiscal crises related to the collapse in housing market.  “Just compensation,” means payment of fair market value of the property being taken – the home.  SB 1451 requires payment of more than the fair market value of the home.”


And there you have it.


The second attorney I checked with was Associate Professor of Law at Loyola Law School in Los Angeles, Lauren Willis, who originally authored a paper back in 2008 that specifically examined the subject of a state taking property in order to satisfy the public good.  The latest version of that paper is titled: “Good for Banks, Good for Borrowers.”  According to Professor Willis’ paper


“Eminent domain is the power of government to take private property for a public purpose, so long as the owner is paid just compensation. Eminent domain can be used to correct deficiencies in the market, particularly when they threaten public tranquility and welfare.

The property hazards, fires, crime, and other social costs imposed by foreclosures will threaten our nation’s tranquility and welfare until foreclosures are dramatically reduced. Families will continue to be uprooted and their children moved from school to school, disruptions that impose intangible and long-term costs on society. We cannot directly devalue loan contracts to reduce our excessive mortgage debt, but we can use eminent domain.

The thousands of families falling into foreclosure and bankruptcy each day will continue for years, with the limited capacity of loan servicers and courts prolonging the problem. The social costs of foreclosure will roll on, increasing the tax burdens and decreasing the quality of life for all households, renter, former homeowner and current homeowner alike.

This plan is not entirely unprecedented; eminent domain has been used to boost homeownership in the U.S. before. At one time in Hawaii, concentrated land ownership was injuring the public tranquility and welfare by preventing ordinary families from owning the property on which they lived. To fix this market failure, the state took land from large landowners and compensated them at fair market value. The state then sold the property to the families who had been living there and paying rent, offering them mortgages through the Hawaii Housing Authority. “


(I can also say that there have been other legal experts at the state capitol and elsewhere that have very carefully reviewed SB 1451 and they are in agreement that the State of Arizona does have the right to do what the bill describes.  And that’s all I have to say about that.)


No More Soup for You!


Robb’s next objection to SB 1451 would have been easily predicted by anyone familiar with the banking lobby’s legendary resistance to change.  According to Robb, “Once the legislature indicates a willingness to abrogate loan agreements, lending in Arizona will be more risky and borrowers will have to pay for that increased risk.”


This is the standard threat that the banking lobby uses when it wants to scare legislators into never voting for anything that would change the status quo as related to lending, because the threat implies that if you do anything the bankers don’t like, there will never be lending again in Arizona.


Well, I’m positively thrilled to have the opportunity reply to this assertion, because as assertions go, this one is absolutely preposterous.  What’s going to happen?  Are they going to blacklist the state?


It’s a bit like thinking that no one would ever want to own a commercial airline again because the federal government grounded the airlines for an entire week following 9-11.


Investors aren’t morons, Rob Robb, they can tell the difference between an extraordinary economic event and a communist regime out to seize private property at every turn.  Maybe Mr. Robb struggles with that distinction, but I’m fairly confident that any investor with more than say $200 to invest can.


What are you asking me to fear, Mr. Robb… that there’ll be no private lending in Arizona?  There’s no private lending in Arizona now.  And there’s not going to be any private lending in Arizona, or anywhere else for that matter, for a long time.  Banks have the same toxic assets clogging up their balance sheets that they had in 2008.  CDOs that have never been traded, valued using their own valuation models, seconds that are essentially worthless.  And off the balance sheet? Don’t even get me started.


In every single year since the financial crisis began, more than 90 percent of all loans have been government funded.  We haven’t had any meaningful private securitization of debt since the summer of 2007.  The securitization market is broken.  Investors lost trust, and once you lose trust you just don’t get it back… you just don’t.


Wake me up when a few of those problems go away and then we can chat about their lending.  Of course, you’ll probably need to call the nurse to wake me because I’ll probably be living in a SNF by then.


Robb also says that, “Arizonans trying to buy a home with a conventional mortgage that doesn’t have a federal guarantee would be out of luck.”


Okay, so obviously Robb doesn’t know that the only lending that exists in this country, for all practical purposes, is government lending.  There are no “conventional mortgages” being offered today that aren’t funded by the federal government.  It’s Fannie, Freddie, or FHA and that’s that.  Well, there’s Ginnie Mae too, if you’re talking VA loans.


And please don’t tell me about the lending on $2 million homes for people with 50% down and 900 FICO scores.  Just say hi to all 11 of them for me, okay?



So, let’s imagine it’s ten years from now.  And because of SB 1451, Arizona’s homeowners are not loaded with debt, and have been current on their loans over the last ten years.  It’s an entire state of great credit risk with equity in their homes enjoying their serenity.


Are you seriously trying to tell me that, faced with that picture, no one will want to lend in Arizona because of something that the state did ten years ago during an economic catastrophe?  Would you care to bet on that, Rob Robb?  There are plenty of lenders that want to start extending credit to people a month after their bankruptcies have been discharged.


And did you know that during the 1930s the government FORCED creditors to take hair cuts of 40 percent, but investors didn’t stop investing as a result.  To the contrary, according to a study conducted by a former Federal Reserve Board Governor and Professor of Economics at the University of Chicago Graduate School of Business, they came out ahead.


Study Shows: “It’s better to forgive than receive.”


Economist Randall S. Kroszner is a former Federal Reserve Board Governor and an economics professor at the University of Chicago Graduate School of Business.


His study, which he describes as an, “Empirical Analysis of Large-Scale Debt Repudiation,” provides evidence of coordinated debt relief creating a win-win-win scenario, leaving all of the involved parties in better financial condition than would have otherwise occurred.  In other words, there are situations when investors, and the economy overall, are best served by forgiving debt.



Professor Kroszner’s paper begins by acquainting us with a clause that, up until 1933, appeared in essentially all long-term contracts, both public and private, known as the “gold clause.”  Its genesis was the inflation that followed the Civil War, and it protected creditors against devaluation of the dollar by indexing to gold the value of the payments they were owed under any given contract.  If the price of gold were to rise during the life of the contract, they could demand payment in gold instead of dollars.


During FDR’s first 100 days, he asked Congress to do away with the gold clause in all public and private contracts. 


Predictably, creditors screamed bloody murder, just as they undoubtedly would today, but the legislature passed a Joint Resolution on June 5, 1933, nullifying all such clauses and when the U.S devalued the dollar in 1934, and the price of gold jumped from $20 an ounce to $35 ounce as a result, the impact was akin to today’s banks granting principal reductions of 40 percent!


Next, creditors challenged the constitutionality of Congress’ Joint Resolution.  The stakes were astronomical for the times.  The U.S. GNP, between 1933 and 1935 was between $55 billion and $72 billion and there was a nominal $100 billion of debt with gold clauses outstanding.  If the court invalidated the resolution, debts would have increased by 69 percent1 and mass bankruptcies would have followed, but in a landmark 5-4 decision, the court upheld the government’s right to repudiate the gold clause.


So, what happened?  Well, bond prices actually WENT UP following the court’s decision to uphold the government’s repudiation of the gold clause.  And Professor Kroszner’s paper presents a very technical examination of the financial impacts to both debt and equities, which also went up, by the way.  But, the details are not important here, because that was then and this is now, and because that was a national event and we’re only talking about the State of Arizona.


The important point to be made is that, based on this historical analysis, there are circumstances when engaging in coordinated forgiveness of debt benefits all parties, including the overall economy.


Read My Lips, No State Guarantee…


Sen. Reagan’s SB 1451 is an entirely new way to handle mortgage financing.  It’s “borrower-centric,” as opposed to being “lender-centric,” so no one gets to make zillions of dollars, as was the norm with the securitization schemes of 2003-2008.  And you’d think that if Robb was going to question the bill, he do it on the grounds of its newness.  But, no… his arguments just start attacking the bill on entirely irrational grounds.


For example he claims that even though the bond financing doesn’t put Arizona on the hook for the bonds… that it does.  According to Robb…


“But it doesn’t matter what she says, or what it says in her legislation, the bonds would sell with an implicit guarantee from the state.”


See what I mean?  How do you argue with someone like this?  I feel like I’m arguing with my wife when she doesn’t want to let me win regardless of whether she’s decided that I’m right.  It doesn’t matter what Sen. Reagan says or what is says in the legislation?  Is that how we assess things in Arizona now… it doesn’t matter what something says or anyone says… all that matters is what’s in Robert Robb’s beautiful mind?


Robb’s piece even goes so far as to describe the relationship between the State of Arizona and this program as being something along the lines of the federal government’s relationship to Fannie Mae and Freddie Mac and that’s just a ridiculous comparison.  Where does he get this stuff?  Does he think he’s writing a John Grisham novel, or covering an actual bill in the state senate?


Senate Bill 1451 only uses PRIVATE MONEY.  There is no government money involved, no subsidies, no guarantees, and no taxes.  This Program utilizes a completely different structure than any current mortgage program.  It includes a cash insurance fund, which won’t be less than 10% and possibly more than 20% of the amount of the bonds issued.  SB 1451 is not securitization and there are no derivatives involved.


In its simplest form, the program sells bonds and uses the money to make loans.  Local banks can participate by lending their money too through the purchase of what are called “Insured Home Certificates.”  Banks that purchase these certificates receive detailed payment history on the homes they are investing in and can therefore look to refinance as they see fit.


Other than all that, it’s still nothing like Fannie and the Fed.  Nothing is like Fannie and the Fed.  And this program’s oversight is a three-member appointed panel who oversee program suppliers, and who are damn near volunteers.


And Rob… There is no state guarantee implied or otherwise… period… and that’s that, okay?  I know you want there to be a guarantee, and I know you’re all worked up about it, but it doesn’t exist so why don’t you go be scared about some other fictional bogey man and leave this one be, you’re just confusing people.


Interestingly, Mr. Robb does say some very flattering things about the bill too.  His words, not mine…


“What Reagan proposes is a remarkably sweet deal. Any underwater homeowner who was current or becomes current could get interest-only refinancing for just the present market value of the home for up to ten years. Who wouldn’t sign up for that?”


Hey, he gets it!  In fact, he took the words right out of my mouth.  So, what’s the problem?


There isn’t one… so instead, Robb just keeps making them up as he goes along.  And don’t stop him cause he’s on a roll.  He just can’t stop talking about an implicit guarantee.  It’s like he recently read a book about Fannie and Freddie, now has “implicit guarantee” in his head and now it’s just rattling around, popping up intermittently.

Stopping the Wave…


Robb closes by showing that he does understand why the program was developed in the first place…


“Arizona is preventing an impending tidal wave of strategic defaults – in which underwater homeowners just walk away from their homes, with knock-on consequences for surrounding property owners.”


And then he says ominously, “Whether such a tidal wave is impending is uncertain. Experts disagree.”


Which experts disagree?  I mean, who specifically?  I’m going to need names and contact information here, because I’m an expert and I don’t disagree in the least. So, please… I want to talk to your “experts.”  Assuming when you use the term experts you don’t mean Realtors and mortgage bankers, because that would be like hearing from Big Tobacco executives about how second hand smoke isn’t nearly as bad for me as people say.


That notwithstanding, Mr. Robb is admitting that it’s “uncertain,” so I guess my question to him would be… What if there IS such an impending wave coming?  What then Mr. Robb?  Do you have a contingency plan for that becoming a reality?  Because I hope you realize that should today’s situation in Arizona worsen significantly, it’ll be nothing but desolation and wretchedness for at least hundreds of thousands of people.  And I can tell by your attitude about this bill that you have absolutely no idea of what it’s like for the majority of the state’s population even now.


I do though.  And I’ll be happy to take you on a tour of your own hometown anytime, just say the word and I’ll pick you up.


Sen. Reagan’s SB 1451 will provide up to 90 percent of Arizona’s homeowners with a choice… a safety net should things worsen.  And it doesn’t stop any of the mega-banks from lending or competing, for that matter.  They are all free to write down the principal balances of loans whenever they’d like to.


What they can’t do is continue to treat the people of Arizona like the people of Greece.  They aren’t going to sit back and say… “You’ll pay your debts and we’ll do nothing until you are experiencing such a level of pain and have made so many hard choices that many won’t even want to go on living.”  That the banks cannot do. The people of Arizona are not going to let that happen.


It looks like a states rights issue to me.  So, let the legislative debate begin.  Time to stand up and be counted.  If the people want it, then it’s up to the legislature to make it happen.


Breaking Points…


According to the Federal Reserve Bank of Atlanta’s December 2011 report, titled “Exploring Impediments to a Real Estate Recovery”…


Negative equity, meaning that a borrower owes more than the house is worth, continues to prevent any sort of recovery in Arizona’s housing market, because it’s the foremost contributor to the high rate of foreclosures.


In the white paper, Moral and Social Constraints to Strategic Default on Mortgages, published July 2009, by Professors Sapienza, Zingales and Guiso, survey data was used to study American households‘ propensity to default when the value of their mortgages exceeded the value of their homes… even if they can afford to pay their mortgage.


The study found that households wouldn’t default with an equity shortfall less than 10% of the value of the house. Yet, 17% of households WOULD default, even if they CAN afford to pay their mortgage, when the equity shortfall reached 50% of the value of their house.


According to a report issued late last year by JPMorgan Chase & Co, strategic defaults are now more likely among jumbo loan-holders than any other type of borrower; nearly 40 percent of jumbo loan delinquencies, are strategic defaults.


There have even been a record number of defaults in Beverly Hills, you know… 90210.  Many wealthy owners could clearly still pay but walked away anyway.  Also worth noting is the fact that only 12 of 180 distressed homes in Beverly Hills are currently up for sale.


Laurie Goodman of Amherst Securities is perhaps the preeminent analyst of the U.S. mortgage market and her data and analysis is relied upon extensively on Wall Street and in the housing industry at large.  According to Goodman…


The moral hazard… strategic default issue… must be addressed by first recognizing it as an economic issue, not a moral one. The point is that a borrower at a 150 CLTV is highly likely to default, regardless of whether or not he can pay.


William C. Dudley, the president of the Federal Reserve Bank of New York, laid out a housing agenda when he spoke at West Point last month. He brought up an idea that the Fed knows will probably become necessary: “reduction of the amount that many borrowers owe while they keep their homes.”


HUD Secretary Shaun Donovan called FHFA’s reluctance to engage in principal reduction, “quasi-religious,” and the moment I read it, I realized he was right… I knew exactly what he meant.


According to Goodman’s latest research, “Borrowers with more severe negative equity and perfect payment histories are defaulting at ~20% per year, nearly as fast as borrowers with equity are refinancing.  We believe the government needs a mandatory program that forgives principal on the 1st lien and substantially eliminates the 2nd lien. Voluntary programs won’t work.”


Even though, in most instances in Arizona, mortgage servicers could maximize their return by writing down the principal on loans, some in the industry say they won’t do it, “because of their inability to distinguish borrowers’ breaking points.”



So, I wonder if Mr. Robb thinks he can distinguish borrowers’ breaking points… is that the plan?  Catch it just in time? Right before Arizona’s economy does an imitation of the final scene in the movie “Thelma & Louise,” and drives right off the edge of the Grand Canyon.


So, it looks like it’s either that, or we get an answer to the question… DOES ARIZONA HAVE THE RIGHT TO SAVE ITSELF?


Mandelman out.



Save Our State!

Want out of the RED? Tell these senators and your elected representatives in both the House and Senate that you’re watching and you want them to VOTE YES on SB 1451.

Don Shooter 602-926-4139           

Steve Pierce 602-926-5584


Find your state assembly and senate representatives CLICK HERE.


Want to hear more? 

Listen to Senator Reagan and her legislative team talk about her groundbreaking bill.

On a Mandelman Matters Podcast



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*1 Prof. Kroszner’s paper states that the gold standard would have increased the contract value by 69% over the nominal value of the contract (that is, to 169% of the nominal contract amount).  When you reduce 169% down to 100% you have reduced the figure by 40%.  So if a house today is 69% underwater, that means the face value of the loan is 169% of full market value, and if that loan is reduced to 100% of full market value, this means the loan has been reduced by 41% (69/169 = .408.)


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