Democratic Government and Eminent Domain

In response to: From Kelo With Love: Revisiting Kelo's Flawed Economics and Vacuous Constitutionalism

Professor Zywicki is right: Kelo is one of the most publicly-maligned decisions in recent Supreme Court history. But it is altogether more debatable whether the hostility was deserved.

Professor Zywicki offers a straightforward economic account and critique of eminent domain. He argues that the fair market value standard is inadequate to compensate people for their subjective harms. This, in turn, raises the possibility that eminent domain will not result in the efficient allocation of resources. Through its power to compel non-voluntary transfers of property, the government may well convey property from a user who values it more to one who values it less, resulting in a net decrease in social welfare. This, he argues, is both inefficient and unfair. The critique is an important if familiar one, but it undersells the breadth of the just compensation standard, applies the concern in an inappropriate context, and fails to appreciate some of eminent domain’s important roles.

There is no doubt that people often have subjective attachments to their property—attachments that are unique to them, and that are wiped out if the government takes their property by eminent domain. I may not have an autographed picture of the Immaculate Reception like Professor Zywicki, but I may have a house that contains childhood memories and ephemeral connections that any other buyer—especially the government—would not value. But this, surprisingly, does not mean that those connections are ignored by the fair market value standard.

As my Brooklyn Law School colleague Brian Lee has recently argued, in an excellent article, Just Undercompensation: The Idiosyncratic Premium in Eminent Domain, forthcoming in the Columbia Law Review, the fair market value standard does include a significant measure of subjective value. Specifically, it includes the average subjective value that sellers demand for their property in consensual transactions. Consider, for example, the problem of valuing a house for purposes of eminent domain. An appraiser will first look for comparable sales data. But anyone selling a comparable house is bound to have some unique subjective value tied up with her property—value that will inform how much that owner will demand for her property when she sells. If a transaction happens, it will be because a buyer valued the house more than the seller, and this includes the seller’s subjective value, whatever its source. If there is a market for autographed pictures of the Immaculate Reception, you can be sure that sellers have demanded a price that includes their own connection to that game, however personal and subjective. The fair market value standard, then, does not ignore all subjective value; it ignores only idiosyncratically high subjective value.

This is no a complete answer to, or rebuttal of, Professor Zywicki’s argument. It is no doubt true that some people do have idiosyncratically high subjective value associated with their property—indeed, Professor Zywicki hints at such value associated with Franco Harris’s catch. And when the government takes property from people with idiosyncratically high subjective value, there is a real chance that the property will not end up in the hands of a higher valuing user. But it may well be that the losses from uncompensated idiosyncratic subjective value are likely to be lower than the costs of foregone public programs, or policy innovations that rely on eminent domain. That, at the end of the day, is an empirical question, and reasonable minds can disagree. But at the very least, property owners’ subjective values are not ignored as much or as often as some people think.

If there is one place, however, where worries about uncompensated subjective value are entirely irrelevant, it is in the proposal to condemn underwater mortgages—the impetus for Professor Zywicki’s comments. That proposal does not call for the government to condemn land, but only to take the mortgages themselves from Wall Street investors. There is simply no subjective value here. No one claims to have autographed copies of famous collateralized debt obligations. The mortgages reflect purely financial instruments. They certainly raise complicated valuation issues, issues I have considered in other contexts. Yes, governments are likely to advocate valuation methodologies that understate the economic reality of the mortgages, but investors will push for the opposite. That is, after all, the nature of the adversary process. But there is no reason in the abstract to think they will be systemically undervalued.

Fundamentally, too, many of the responses to Kelo have failed to appreciate the important roles that eminent domain can play. Professor Zywicki argues that eminent domain was unnecessary for the land assembly in Kelo. And, indeed, he suggests that eminent domain is rarely necessary for effectuating land assemblies. He concludes, quite forcefully, that, at the least, “the use of the Takings power to take underwater mortgages is an absurd claim completely disconnected from the underlying rationale of the takings power.”

Taking underwater mortgages is, of course, quite different from taking land as part of a land assembly. But at a sufficient level of generality they have more in common than it might seem. The argument for condemning underwater mortgages depends, entirely, on a particular account of current mortgage markets, the accuracy of which is beyond the scope of this short response. But the claim, at least, is that everyone loses in the foreclosure process. The borrower loses in the most obvious sense: she loses her home, her credit rating, and so forth. But banks and investors lose too. Foreclosure almost always results in fire-sale prices when selling the underlying collateral. For underwater mortgages, this will exacerbate losses. Moreover, foreclosures tend to drive down nearby property values. This, too, harms banks, because it makes any mortgages on those nearby properties less valuable and more likely to go into foreclosure. There is a death-spiral aspect to all of this, and widespread foreclosures can destroy a community, harming homeowners, the public, and lenders alike.

So why would lenders allow this to happen? Why would they foreclose on property instead of working out loans, if the potential consequences in the current market are so devastating for everyone? The answer, according to one account, is a kind of collective action problem. The economic stakeholders are numerous and diverse, and it is prohibitively difficult for them to come together to take efficient and beneficial action. In short, coordination is difficult because transactions are difficult and costly. But overcoming transaction costs is squarely within the core justification for government action and for eminent domain. The holdout problem in land assembly is, at the end of the day, simply another form of transaction cost.

This is not intended to be an endorsement of the proposal to take mortgages by eminent domain. Such a plan may well be misguided, and bad policy. But it does not fall as far outside of the core functions of the eminent domain power as Professor Zywicki suggests. It also points to another unheralded role of eminent domain in preserving policy flexibility for future governments.

It is a core principle of democracy that one government cannot irrevocably bind future governments. For this reason, governments are unable to pass unrepealable legislation, and even constitutions can be amended. In a democracy, each government must be capable of responding to the policy preferences of its own constituents. This is referred to as a problem of entrenchment; a government cannot entrench its policy preferences in a way that binds future governments.

The interesting problem is that entrenchment can take much broader forms than just unrepealable legislation. Indeed, as I have argued elsewhere, a government can try to lock in its policy preferences by relying on private law mechanisms, like contracts and property. A local government that wishes, for example, to entrench a development agenda against an ascendant environmental group may grant building permits and otherwise act in ways that allows development rights to vest. Once vested, those rights become largely immune from subsequent regulatory change. Or a government might convey away assets—like conservation easements, mineral rights, or even parking meters—that implicate policy judgments. In those instances, a subsequent government’s ability to change course—its ability, in short, to reclaim policy control—may well require eminent domain. Removing eminent domain from governments’ toolkits may unintentionally transform once-routine actions and decisions into problematically or even impermissibly entrenching ones. Governments that ignore this core democratic function of eminent domain risk locking policies into the past.

In this light, the proposal to condemn underwater mortgages can perhaps be seen as an effort to overcome an earlier regulatory failure—a failure by the federal government to regulate the CDO market, and even the failure at the state level to provide adequate consumer protection laws. Depriving states, counties, and local governments with the power of eminent domain now means that they must live with prior governments’ regulatory failures for years if not decades to come.