Bloomberg reports Richmond Escalates Eminent Domain Plan With Loan Offers.

Richmond, California, is backing a plan to buy mortgages in low-income areas for as little as 25 cents on the dollar and may force the sales under eminent domain laws, moving forward with a controversial program that would potentially seize control of home loans from investors.

Richmond is the farthest along in a plan advocated by Steven Gluckstern’s Mortgage Resolution Partners LLC for U.S. cities to confiscate mortgages and write them down in an effort to help homeowners escape oversized debt burdens. The idea has drawn opposition from bondholders such as Pacific Investment Management Co. and DoubleLine Capital LP and at least 18 trade groups representing the finance industry, homebuilders and real estate firms. 

None of the 32 servicer and bond trustees that oversee the loans will likely sell willingly, Chris Killian, head of the securitization group for the Securities Industry and Financial Markets Association, Wall Street’s largest lobbying group, said in a phone interview.

“You just can’t really sell performing loans out of securitizations,” Killian said. “Additionally, everybody we talk to in the industry thinks this is a bad idea that will be bad for the mortgage markets.”

Eminent Domain

Eminent domain (confiscation of private property for the public good), have been upheld time and time again, most recently in the infamous US Supreme Court decision Kelo v. City of New London.

Kelo v. City of New London, 545 U.S. 469 (2005) was a case decided by the Supreme Court of the United States involving the use of eminent domain to transfer land from one private owner to another private owner to further economic development. In a 5–4 decision, the Court held that the general benefits a community enjoyed from economic growth qualified private redevelopment plans as a permissible “public use” under the Takings Clause of the Fifth Amendment.

The case arose in the context of condemnation by the city of New London, Connecticut, of privately owned real property, so that it could be used as part of a “comprehensive redevelopment plan.” However, the private developer was unable to obtain financing and abandoned the redevelopment project, leaving the land as an empty lot, which was eventually turned into a temporary dump.

Public reaction to the decision was highly unfavorable. Much of the public viewed the outcome as a gross violation of property rights and as a misinterpretation of the Fifth Amendment, the consequence of which would be to benefit large corporations at the expense of individual homeowners and local communities. Some in the legal profession construed the public’s outrage as being directed not at the interpretation of legal principles involved in the case, but at the broad moral principles of the general outcome. Federal appeals court judge Richard Posner wrote that the political response to Kelo is “evidence of [the decision’s] pragmatic soundness.” Judicial action would be unnecessary, Posner suggested, because the political process could take care of the problem.”

Prior to Kelo, seven states specifically prohibited the use of eminent domain for economic development except to eliminate blight: Arkansas, Florida, Kansas, Kentucky, Maine, New Hampshire, South Carolina and Washington. As of June 2012, 44 states had enacted some type of reform legislation in response to the Kelo decision. Of those states, 22 enacted laws that severely inhibited the takings allowed by the Kelo decision, while the rest enacted laws that place some limits on the power of municipalities to invoke eminent domain for economic development. The remaining eight states have not passed laws to limit the power of eminent domain for economic development.

End Result of Seizure: A Dump

There you have it. The result of the seizure (whose intent was a mall), turned useful tax-payer property into a vacant lot, then a dump when the developer could not get financing.

44 states passed laws restricting eminent domain as a response to that poor US supreme court decision. One of those states was California.

Proposition 99

California passed Proposition 99 in 2008.

Summary Prepared by the Attorney General

  • Bars state and local governments from using eminent domain to acquire an owner-occupied residence, as defined, for conveyance to a private person or business entity.
  • Creates exceptions for public work or improvement, public health and safety protection, and crime prevention.

Ridiculously Broad Interpretations

What constitutes “public work or improvement, public health and safety protection, and crime prevention”?

The statement is so broad as to be 100% meaningless. Was that the intent of Prop 99 all along?

Non-Fair Value Seizures

The law requires the owner to receive “fair value” for the seizure. Of course it is the state that gets to define “fair value”.

Richmond does not even want to pay fair value for the mortgages. Please consider these additional details in the New York Times article A City Invokes Seizure Laws to Save Homes.

On Monday, the city sent a round of letters to the owners and servicers of the loans, offering to buy 626 underwater loans. In some cases, the homeowner is already behind on the payments. Others are considered to be at risk of default, mainly because home values have fallen so much that the homeowner has little incentive to keep paying.

Many cities, particularly those where minority residents were steered into predatory loans, face a situation similar to that in Richmond, which is largely black and Hispanic. About two dozen other local and state governments, including Newark, Seattle and a handful of cities in California, are looking at the eminent domain strategy, according to a count by Robert Hockett, a Cornell University law professor and one of the plan’s chief proponents. Irvington, N.J., passed a resolution supporting its use in July. North Las Vegas will consider an eminent domain proposal in August, and El Monte, Calif., is poised to act after hearing out the opposition this week.

 The city is offering to buy the loans at what it considers the fair market value. In a hypothetical example, a home mortgaged for $400,000 is now worth $200,000. The city plans to buy the loan for $160,000, or about 80 percent of the value of the home, a discount that factors in the risk of default.

Then, the city would write down the debt to $190,000 and allow the homeowner to refinance at the new amount, probably through a government program. The $30,000 difference goes to the city, the investors who put up the money to buy the loan, closing costs and M.R.P. The homeowner would go from owing twice what the home is worth to having $10,000 in equity.

All of the loans in question are tied up in what are called private label securities, meaning they were bundled and sold to private investors. Such loans are generally the most unfavorable to borrowers and the most likely to default, Mr. Gluckstern said. But they are also the most difficult to modify because they are controlled by loan servicers and trustees for the investors, not the investors themselves.

Sappy Details

The Times article disclosed the sappy details of a person who paid $420,000 for a home now worth $125,000.

To what extent should government intervene in such affairs?

The obvious answer is “none”. The homeowner can walk away is he wants, and if he doesn’t want, then he can keep paying the mortgage.

Questionable Details

As long as someone is willing to keep paying the mortgage, then the value of the loan is more than the alleged “fair value” offered by the city.

And note the $30,000 difference to the city and the new investors in the proposed scheme.

In essence, the city wants to confiscate private property not for the “public good” but for the good of its own finances, for the good of new lenders, for the good of one set of private persons, at the expense of another set of private persons, at a very questionable “fair value” price.

I contend this is not only morally wrong, but blatantly illegal.

Should this socialist wealth redistribution scheme actually be upheld by the courts, it will unleash a torrent of increasingly ridiculous schemes, while further undermining property ownership rights, the very thing governments ought to protect.

Mike “Mish” Shedlock