California City Okays Eminent Domain to Seize Underwater Mortgages
A city of 105,000 persons near San Francisco, Calif., has become the first municipality in the nation to approve seizing “underwater” mortgages.
The Richmond City Council approved the measure in September on a 4-3 vote. Under eminent domain, a government may seize property for a public purpose. City officials say that purpose is to keep properties out of foreclosure and avoid blight. A mortgage is "underwater" when the amount owed exceeds the value of the property.
The proposal had the backing of Mayor Gayle McLaughlin. Barring legal challenges that are already underway, city staff will work with San Francisco-based Mortgage Resolution Partners LLC to implement the plan. The city will acquire the loans for less than the properties are valued and then sell them to MRP, which will receive a fee for every mortgage that is acquired before reselling them for a profit. The mortgages would be refinanced with principal on the loans reduced to lower monthly payments and avoid foreclosures.
“This is a gross abuse of eminent domain that will raise homeownership costs in the Richmond area as banks and investors treat the market there with the caution of those who've discovered rule of law and contracts is no longer defended by local authorities,” said Anthony Randazzo, director of economic research for Los Angeles-based Reason Foundation.
‘The Definition of Crony Capitalism’
“It is easy to understand frustration with financial institutions who contributed to the housing mess nationwide, but that is no cause to force mortgage investors, which range from big banks to teachers pension funds, to take losses on mortgages they don't want to modify,” Randazzo said. “This particular situation is made even worse when you consider the cronyism of a private company—Mortgage Resolution Partners—colluding with public officials on the eminent domain authorization for which homes will be seized below mortgage value by government and then sold to MRP who will then resell the cheaper mortgages back into the marketplace at a profit. It’s the definition of crony capitalism.”
Richmond in August tried to buy hundreds of underwater mortgages but was rebuffed.
“[Wells Fargo] does not have the contractual authority to sell the loans and is not aware of any other party having the contractual authority to sell the loans or consider your offer,” wrote David Gorsche, the bank’s assistant general counsel, in response to the city’s purchase offer.
No Allowance for Voluntary Sales
On its Web site, MRP tacitly acknowledges Gorsche’s statement: “Private securitization trusts [of which Wells Fargo is one] hold approximately $1.1 trillion of loans; we could offer to buy their underwater loans, but their trust agreements do not allow for voluntary sales. Eminent domain allows us to purchase those loans as well as related second mortgage loans if the holders of the seconds are also unable (or unwilling) to sell. Eminent domain is a way to successfully consolidate ownership of a homeowner's mortgage loans in the hands of someone with the economic incentive and freedom to modify or otherwise resolve them.”
MRP disputes the legal arguments against using eminent domain to acquire mortgages, writing, "the Contract Clause has never been thought to protect against the exercise of the power of eminent domain."
MRP has been floating the idea in various places around the country. The City of North Las Vegas rejected a similar proposal from MRP one week earlier. San Bernardino County in California has also rejected the plan.
Jeffrey Wright is a Richmond-area real estate broker and former president of the West Contra County Association of Realtors who says the mayor and majority of the City Council are “on a social justice crusade. They believe the housing problem was created by the mortgage industry, so it’s necessary for the city to take action to save the residents.”
Most Mortgages Current on Payments
But like Reason Foundation’s Randazzo, Wright says the main beneficiaries will be MRP and its investors. The city has already identified 624 mortgages it wants to acquire, and 444 of them are “performing” mortgages, meaning the borrowers are current on their payments and in no danger of foreclosure.
“Only 180 of the 624 mortgages are non-performing,” Wright said. “I have a list of all those properties in my hand as we speak. The city gets portrayed as heavily minority concentration, a certain income class. When I look at the list of homes that have been identified [for mortgage seizure], the vast majority of them are in the nicer areas of town.”
He said the consequences of the city’s decision to use eminent domain to seize mortgages for MRP “will be a decline in property values and increased costs to consumers to obtain mortgages” because of the added risks lenders now face in Richmond.
Federal Govt., Legal Challenges
Many in the finance and real estate industries oppose the process, as do federal government officials. The Federal Housing Finance Agency recently announced it would require the government-sponsored mortgage agencies Fannie Mae and Freddie Mac to reduce or stop doing business where such proposals get approved. That could put an end to mortgage refinancing in Richmond.
Even before the City Council’s approval, the plan had sparked a legal challenge. Mortgage investors have sued through Wells Fargo & Co., Deutsche Bank AG, and Bank of New York Mellon to block the plan, arguing it violates Constitutional protections against impairing private contracts.