Forget eminent domain, invoke squatter’s rights!
By claiming adverse possession, delinquent mortgage squatters may be able to rescind a lender’s right to foreclose if the borrower made no payments for five years, paid their taxes, and failed to respond to any lender loan modification offers, and the lender issued no Notice of Default.
When Richmond, California, announced a plan to seize underwater mortgages, the parties holding those mortgages not surprisingly freaked out. Five years ago, enabled by mark-to-model accounting, lenders embarked on a strategy of loan modification can-kicking to delay or avoid recognizing losses on bad loans. Lenders planned to remove the distressed inventory from the market, allow house prices to rebound to improve their capital recovery, then resolve their bad bubble-era loans. Their plan works well, but if the City of Richmond is successful in forcing them to sell the mortgage for a price less than the fair-market value of the underlying collateral – which is the eminent domain plan — then lenders will be forced to recognize billions in losses they hoped to avoid. This is a life or death struggle for lenders; losing could even force them into bankruptcy.
The eminent domain strategy has many legal hurdles to overcome: first, lenders will obviously fight this to the bitter end, so attorney’s fees will be very high; second, the City must obtain these loans at a value less than the fair-market value of the underlying collateral, while lenders carry these loans on their books at the value determined by their mark-to-fantasy accounting. Determining the value of these loans will be the most contentious issue of the eminent domain proceeding, and if the City does not get the loans for the value they want — which I believe unlikely — the entire scheme falls apart. Despite the obstacles to success, the lending industry worries about the prospect, and lenders resort to emotional rhetoric to make their case.
Richmond plan impacts pensions, not fat cats on Wall Street
The Richmond, Calif., city council is pursuing a plan to use the city’s power of eminent domain to force bondholders to sell underwater loans, allowing homeowners to restructure their mortgages. And it’s not surprising that investor groups continue to be fundamentally opposed to such actions and continued to speak out against the practice at the ABS Vegas conference currently underway in Las Vegas.
Mayor Gayle McLaughlin has led the charge toward a partnership with San Francisco investment firm Mortgage Resolution Partners to buy 624 city residents’ mortgages that are underwater, or that owe more money than the home is currently worth.
Other cities in areas still suffering through this housing recovery have considered it, as well. North Las Vegas, for example, rejected the notion.
Will eminent domain be an issue in other regions?
Scott Simon, a former partner with PIMCO, says despite the good-sounding intentions, this is theft, plain and simple, and it hurts the very middle class that it supposedly helps.
“MRP and Richmond are stealing,” Simon said. “It’s their 401ks and pension plans, firemen and teachers retirements, not some fatcat Wall Street investor that they’re going after. And it will hurt investment and lenders. Why would you lend money in a place where government can come in and take it?”
While I imagine this rhetoric went over well in the conference for lenders, his emotional reaction overlooks a number of reasons why this form of “stealing” would be a good thing.
Lenders should be concerned about lending money under circumstances where they may have difficulty recovering their capital if the borrower defaults; that’s prudent lending practice. If any municipality is successful in bringing an eminent domain case, lenders will consider blackballing that municipality, but such a gambit will fail; once the precedent is set, any municipality anywhere will be able to use this tool, so the problem won’t be contained — and that wouldn’t be a bad thing.[dfads params=’groups=165&limit=1′]
If lenders knew they could potentially be forced to recognize losses on underwater mortgages, something they don’t fear now due to the moral hazard spawned by the various bailout measures enacted to save them from their own incompetence, if lenders knew the threat was real, they would be far more concerned about creating conditions where borrowers end up underwater. Lenders have no need to fear eminent domain if borrowers are never underwater.
So how do lenders avoid holding notes over underwater borrowers? Primarily, lenders would force borrowers to use substantial down payments to give lenders a cushion against the borrower ever being underwater. This in turn would help prevent future housing bubbles and busts which also helps prevent borrowers from ever falling underwater.
In my opinion, lenders need to fear the ramifications of inflating housing bubbles and dealing with the problems of legions of underwater borrowers. I wrote about this effect in Strategic default is moral imperative to prevent future housing bubbles. But there is one other way this can be accomplished.
Attorneys constantly search for new legal grounds to help clients, irrespective of the morality of the defense. The idea of using eminent domain to obtain mortgages was one such creative idea, taking an existing law and set of procedures and applying it to a new area. I have a similar idea I freely offer to any attorney who wants to pursue it: invoke squatter’s rights through adverse possession to extinguish a lender’s right to call an auction under a mortgage agreement.
California law allows a person to claim adverse possession after continuously occupying a property and paying all property taxes for five years. Many, if not most, delinquent mortgage squatters occupied the property for five years and paid property taxes, so they meet this requirement; however, here’s where the application of an old law and procedure gets applied in a new way: the borrower needs to argue that despite already being on title that by not paying the promissory note, the owner is in fact adversely possessing the property in an open and notorious manner against the lender who has claim against title. Since the lender has not exercised their right to call an auction per the terms of the mortgage agreement, and five years has passed since the borrower quit making payments, the lender forfeits all rights to call an auction in the future.
In cases of long-term squatting (five years or more) where the borrower has completely ignored any lender communications and offers of loan modifications, and the lender has not filed any notices, a borrower should be able to argue they meet the conditions of adverse possession and thereby extinguish the lender’s right to call a foreclosure auction.
Lenders thought they were afraid of eminent domain, but if one of these cases were successful, tens of thousands of delinquent mortgage squatters will suddenly have free homes, and lenders will be forced to recognize 100% losses on those mortgages.
For as appalling as I would find seeing those delinquent mortgage squatters enriched that way, I would enjoy an inner glee over the destruction of the banks such an action would cause.
1268 North KENNYMEAD St Orange Park Acres, CA 92869
$1,100,000 …….. Asking Price
$1,200,000 ………. Purchase Price
7/29/2010 ………. Purchase Date
($100,000) ………. Gross Gain (Loss)
($88,000) ………… Commissions and Costs at 8%
($188,000) ………. Net Gain (Loss)
-8.3% ………. Gross Percent Change
-15.7% ………. Net Percent Change
-2.5% ………… Annual Appreciation
Cost of Home Ownership
$1,100,000 …….. Asking Price
$220,000 ………… 20% Down Conventional
4.92% …………. Mortgage Interest Rate
30 ……………… Number of Years
$880,000 …….. Mortgage
$228,720 ………. Income Requirement
$4,681 ………… Monthly Mortgage Payment
$953 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$229 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$45 ………… Homeowners Association Fees
$5,909 ………. Monthly Cash Outlays
($1,534) ………. Tax Savings
($1,073) ………. Principal Amortization
$418 ………….. Opportunity Cost of Down Payment
$158 ………….. Maintenance and Replacement Reserves
$3,877 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$12,500 ………… Furnishing and Move-In Costs at 1% + $1,500
$12,500 ………… Closing Costs at 1% + $1,500
$8,800 ………… Interest Points at 1%
$220,000 ………… Down Payment
$253,800 ………. Total Cash Costs
$59,400 ………. Emergency Cash Reserves
$313,200 ………. Total Savings Needed