The Holdout Myth Underlying Current Takings Doctrine

by Brandon Kressin

In 2005, the Supreme Court decided Kelo v. City of New London, a landmark Fifth Amendment case that effectively grants the government license to seize private property for whatever purpose it deems in the public interest.[i] Kelo involved a local redevelopment project in the city of New London, Connecticut. The city wished to bulldoze a small neighborhood and hand the property over to private developers for commercial use. The Court ruled that the economic growth that the city anticipated resulting from this conversion qualified as a “public use” within the meaning of the Fifth Amendment’s takings clause. Therefore, existing property owners such as Suzette Kelo would be forced to give up their homes and accept court-determined compensation.

The scope of this eminent domain power has been highly controversial and the majority of states passed laws strengthening protections for private property rights in the wake of the decision. But economic growth takings such as that which formed the basis for the Kelo dispute continue unabated. Local governments in major states such as California and New York enjoy practically unfettered power to force private landowners to sell their homes to powerful developers at prices determined by courts. These prices routinely undercompensate the small landowners, who receive nothing for their destroyed business goodwill or the subjective values they gain from living or working in the neighborhood from which they are uprooted.

Much of the debate over current takings doctrine revolves around the meaning of the term “public use.” Opponents of the Kelo decision argue that the original public meaning of the term requires a stricter test for permissible takings. In her dissent in Kelo, Justice O’Connor argued that only economic takings that are necessary to abate a public nuisance such as blight should be permissible. Justice Thomas’ dissent proposes an even stricter test that would overturn past precedent and require that the taken property be put under government ownership.

Proponents of the Court’s decision, on the other hand, argue that the Fifth Amendment’s use of the term “public use” requires application of a far more deferential standard by courts review legislative decisions. William Treanor, for instance, surveys colonial and post-revolutionary governments’ use of takings in the eighteenth century and argues that the takings clause places few if any restrictions on the state’s ability to seize private property so long as compensation is paid.[ii] While his account of the original understanding of the Fifth Amendment is disputed[iii], proponents of economic takings argue that the phrasing of the Amendment is at the very least ambiguous. After all, the Amendment never even explicitly outlaws non-public use takings. It merely requires that public use takings be compensated. One could even go so far as to argue that by implication non-public use takings require no compensation (though no one has made that absurd argument as far as I can tell). In the face of a vague constitutional standard, the argument goes, we should err on the side of allowing legislatures to act in the public’s interest. Proponents of economic takings then point to the “holdout problem” boogeyman to argue that such takings are necessary from an efficiency perspective.

The holdout justification for economic takings is based on the idea that it is very expensive to assemble small properties for conversion into large redevelopment projects. The problem is compounded when existing property owners act strategically and “holdout” for higher prices than what they would normally accept to sell their property. The holdouts behave in this way when they recognize that the developer has already sunk a great deal of cost into the project, meaning that they are loath to walk away. Holdouts thus believe that they are in a strong position to extract the majority of the consumer surplus from any sale to the developer, so they hold out for high prices. This narrows the bargaining window for voluntary transactions between the property owner and the developer and may result in many otherwise efficient transfers not taking place. Eminent domain claims to solve for this holdout problem by forcing the property owner to transfer title to the developer in return for a court-determined price.

Most legal discussions of eminent domain seem to assume the validity of the holdout justification without examining whether it is actually a problem in the first place. But this ignores the fact that various free-market mechanisms exist and have been frequently used to avoid such holdout problems without state interference. Land aggregation has been accomplished throughout our history, and continues to be accomplished today, without the intrusive and coercive use of eminent domain. If such aggregation is possible, then perhaps we should err on the side of protecting the subjective values that private property owners put in their homes that are not reflected by market prices.

One popular method of aggregating small parcels of land is secret purchases. Large developers frequently employ agents and dummy companies to discretely purchase small parcels of land that will later be aggregated into one plot. The property owners are thus not tempted to behave strategically and dramatically misrepresent their subjective valuation of their properties. The land on which Disney World sits in Orlando was largely aggregated in this way, and a 1974 article by Peter Hellman in New York Magazine describes in detail how the land currently occupied by the Citigroup Center was put together.[iv] The article describes the process as onerously long and expensive, but we must take note of the fact that the aggregation ultimately succeeded and Citibank built its tower.

Another method of free-market land aggregation might be referred to as combinatorial auctions. Bruce Benson describes this method in an article in the Independent Review.[v] He introduces the subject by referencing a clever solution to the holdout problem suggested by Steven Landsburg.[vi] Landsburg frames his solution in the context of Joseph Conrad’s novel Typhoon. As Benson summarizes:

A number of sailors stored their gold coins in personal boxes in the ship’s safe, but a severe storm caused the boxes to break open and mixed all of the coins together. Everyone knows how many coins he had placed in the safe, but no one knew how many the others had placed there. Therefore, everyone had an incentive to claim that he had put more coins in the safe than he actually had, and the captain’s problem was to determine how to divide the coins to give each sailor his actual savings. Landsburg’s proposed solution: “Have each sailor write down the number of coins he is entitled to. Collect the papers and distribute the coins. [But] [a]nnounce in advance that if the numbers on the papers don’t add up to the correct total, you will throw all the coins overboard.” This scheme clearly reduces and perhaps eliminates the incentive to hold out for more coins than the men had actually contributed.[vii]

How would a developer apply this solution in the context of land aggregation? The developer would inform the owners of the parcels of land that she is attempting to aggregate that she is interested in purchasing their land. But, she must make it clear that she is only interested in either buying all of their parcels or none at all. She would then ask the landowners to individually submit the minimum amount that they would be willing to accept to sell their land. The landowners no longer have incentives to misrepresent their subjective valuations of their land, because if they do so then their combined offers might well exceed the amount that the developer is willing to pay. Instead, the landowners are in the same position as they would be if they were engaged with a smaller purchaser. They will offer to sell for a price that they believe makes them better off, but not one so high that it will scare the purchaser away.

So, if combinatorial auctions are such a great solution to the holdout problem, then why don’t developers use them? As Benson points out, they do. He reports that several large firms that routinely engage in such land aggregations (such as Sears, Wal-Mart, Kmart, and Ford) successfully use combinatorial auctions to mitigate the holdout problem. But, if you are a developer in a state like New York or California and you know that you can get the land through eminent domain at a bargain price, why bother? The use of economic takings to redistribute private property to developers thus opens the door to inefficient and unfair property transfers. It does so to solve for a holdout problem that turns out to be largely mythological. Perhaps, in light of the vagueness of the “public use” phrasing in the Fifth Amendment, we should therefore err on the side of protecting property owners and leave land aggregation for the market to figure out.

[i] Kelo v. City of New London, 545 U.S. 469 (2005).

[ii] William Michael Treanor, The Original Understanding of the Takings Clause and the Political Process, 95 Colum. L. Rev. 782 (1995).

[iii] See, e.g., Nicole Stelle Garnett, “No Taking With A Touching?” Questions From an Armchair Originalist, 45 San Diego L. Rev. 761 (2008); Eric R. Claeys, Takings Regulations, and Natural Property Rights, 88 Cornell L. Rev. 1549 (2003); Andrew Gold, Regulatory Takings and Original Intent: The Direct, Physical Takings Thesis “Goes Too Far”, 49 Am. U. L. Rev. 181 (1999); Kris W. Kobach, The Origins of Regulatory Takings: Setting the Record Straight, 1996 Utah L. Rev. 1211 (1996); David A. Thomas, Finding More Pieces for the Takings Puzzle: How Correcting History Can Clarify Doctrine, 75 U. Colo. L. Rev. 497 (2004).

[iv] Peter Hellman, How They Assembled the Most Expensive Block in New York’s History, N.Y. Mag., Feb. 25, 1974, at 30.

[vi] Steven E. Landsburg, The Armchair Economist: Economics and Everyday Life (1993).

[vii] 10 Independent Rev. at 171.