Richmond, CA, moves to seize mortgages through eminent domain
In what will turn out to be an epic and precedent setting move, the city of Richmond, California, is moving ahead with plans to condemn the mortgages on underwater houses in an attempt to provide mortgage relief to its citizens.
First, I want to say this is a spectacularly bad idea. I first wrote about this issue in June of 2012 in the post Robert Shiller has completely lost his mind. My problem with the idea is as follows:
Yes, mortgage lenders need to write down the amounts owed by delinquent loan owners, but they don’t need to give them the house in the process. Lenders need to foreclose on delinquent borrowers and get them out of the property so a borrower ready, willing, and able to make the payments can live in the house. Why does his solution need to keep the undeserving in the houses rightfully belonging to others?
The last thing we need is to write down the mortgages of all underwater loan owners to fair market value and give them a pass. What about all the HELOC abusers? Do we really want to give them trillions in free money? That is the ultimate extreme of moral hazard. Who would ever borrow responsibly again in the future? Wouldn’t everyone keep their HELOCs maxed hoping for another crash so taxpayers could pay them off?
Plus, this is not for the collective good. This is for the good of a few loan owners. Perhaps some homeowners might benefit from higher house prices, but how much do they need to pay for the bailout to get this benefit? Renters get no benefit at all, and future homebuyers get screwed.
What about all the investors who will lose money in the deal? What about the pensioners who bought mortgage-backed securities for the cashflow in their retirement. We are supposed to screw them to save HELOC abusers and loan owners?
Despite my reservations about implementing this idea, there is one silver lining which I touched on in the post Eminent domain of mortgages can deter future housing bubbles.
First, it must be determined that eminent domain of mortgages is in the public’s best interest. In a recent dipshit editorial in the New York Times, the author asked, “Can there be any doubt that keeping people in their homes constitutes a legitimate public purpose?” Well, actually there is some doubt on this point. First, this is interference in a private contract between two parties that has no bearing on the broader general public. Condemning these mortgages benefits the individuals who receive mortgage write downs at the expense of those who are due payments on these loans. There is no public good in that. Plus, any principal reduction is laden with moral hazard which is a detriment to the public good.
Second, the value of these mortgages is not the value of the underlying collateral. In an eminent domain process, the parties must agree on the value of the asset being acquired. If they don’t it goes to court, which most of these cases undoubtedly will. The banks hold these notes, both performing and non-performing, on their books at original book value minus any amortization. In an eminent domain proceeding, the lender will argue that is the value of the mortgage. If banks must abandon mark-to-fantasy accounting on their non-performing loans and must mark these loans to market — something a successful eminent domain proceeding would force to happen — then the losses to banks and investors will be staggering. Most of the banks will be proven insolvent.
In the case of performing loans, the situation is much more difficult because the banks can rightfully argue the loan is still worth its full face value. After all, the borrower is still paying as agreed. The value of that note is face value if the borrower continues to pay until prices recover. If the city starts an eminent domain proceeding on a performing loan, they will be forced to pay full face value for the loan, then they will be the bagholder if the borrower defaults.
Think what happens then if the city uses eminent domain on non-performing loans and gives those borrowers principal reduction and fails to acquire any performing loans. This would create a huge incentive to strategically default. Basically, any loanowner who quit paying the mortgage would get principal reduction and any loanowner who kept paying would get nothing. Does the city want to buy every mortgage in town? Once this got rolling, they would have to because everyone would quit paying to get the debt relief.
What happens to the property if the delinquent borrower whose mortgage the city just bought does not want to make a deal? The false assumption behind this plan is that every underwater loanowner wants to stay in the property and pay a mortgage. What if the former loan owner doesn’t want to accept the city’s new terms for the loan? Will the city then foreclose and boot them out like the banker would have? What will the cities do with the homes they acquire this way?
Third, the ability to use eminent domain gives the city the opportunity to play the real estate cycle for its own benefit. What if cities start using this to acquire vacant houses or offices? The city could buy up the distressed properties to profit from the rebound. Is this something we want cities doing?
Eminent domain as bubble deterrent
If lenders faced the risk that they may be forced to write down principal balances in the event of a price drop — something the precedent of using eminent domain to acquire underwater mortgages makes real — then lenders would adjust their lending practices going forward. The first thing they would all do is raise their down payment requirements. Since lenders all know 30% to 50% declines in price are possible, then they will start demanding 30% to 50% down payment cushions to protect themselves from potential losses. The only loans with smaller down payments would be government guaranteed loans where the taxpayer makes up the difference for a loss caused by an eminent domain action. The jumbo market would be dead, permanently.
The positive thing lenders would do is to carefully research what causes housing bubbles and enact real changes to prevent them. The bottom line is that prices don’t decline 30% to 50% if prices don’t become grossly inflated. The best thing lenders could do to protect themselves is to determine the cashflow value of the property. If lenders knew they could take the property back and rent it for enough to service the payment, they would have some assurance the property was not overvalued. Of course, this would greatly curtail lending, which isn’t what lenders want, but it’s lender air that inflates bubbles. The fear of eminent domain would go a low way toward preventing the next housing bubble.
So how does the City of Richmond think this will turn out?
… Scarcely touched by the nation’s housing recovery and tired of waiting for federal help, Richmond is about to become the first city in the nation to try eminent domain as a way to stop foreclosures.
The results will be closely watched by both Wall Street banks, which have vigorously opposed the use of eminent domain to buy mortgages and reduce homeowner debt, and a host of cities across the country that are considering emulating Richmond.
The banks have warned that such a move will bring down a hail of lawsuits and all but halt mortgage lending in any city with the temerity to try it.
… “We’re not willing to back down on this,” said Gayle McLaughlin, the former schoolteacher who is serving her second term as Richmond’s mayor. “They can put forward as much pressure as they would like but I’m very committed to this program and I’m very committed to the well-being of our neighborhoods.”
They will squander taxpayer funds with endless lawsuits which they will lose in the end.
Despite rising home prices in many parts of the country, including California, roughly half of all homeowners with mortgages in Richmond are underwater, meaning they owe more — in some cases three or four times as much more — than their home is currently worth.
And if they are successful, the 50% who get no benefit from this will pay for the legal actions, and when lending dries up in their city, they won’t be able to sell their homes. Those who are not underwater should vigorously oppose this action.
…But the cities face an uphill battle. Some have already backed off, and those that proceed will be challenged in court. After San Bernardino County dropped the idea earlier this year, a network of housing groups and unions began working to win community support and develop nonprofit alternatives to Mortgage Resolution Partners, the firm that is managing the Richmond program.“Our local electeds can’t do this alone, they need the backup support from their constituents,” said Amy Schur, a campaign director for the national Home Defenders League. “That’s what’s been the game changer in this effort.”
Richmond is offering to buy both current and delinquent loans. To defend against the charge that irresponsible homeowners who used their homes as A.T.M.’s are being helped at the expense of investors, the first pool of 626 loans does not include any homes with large second mortgages, said Steven M. Gluckstern, the chairman of Mortgage Resolution Partners.
I guess the next round will include HELOC abusers, right?
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.
Do they really think the lenders who have a $400,000 loan on their books will roll over and sell it for $160,000? As I explained above, the value of the loan is not the value of the underlying collateral, and it certainly isn’t a discount to the underlying collateral. Will the city still go ahead with this if they are required to pay well over collateral value? That’s what will happen if this goes to court, which it will.
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. If Richmond’s purchase offer is declined, the city intends to use eminent domain to condemn and buy the loans.
The banks and the real estate industry have argued that such a move would be unprecedented and unconstitutional. But Mr. Hockett says that all types of property, not just land and buildings, are subject to eminent domain if the government can show it is needed to promote the public good, in this case fighting blight and keeping communities intact. Railroad stocks, private bus companies, sports teams and even some mortgages have been subject to eminent domain.
…Representative John Campbell, Republican of California, has introduced a bill that would prohibit Fannie, Freddie and the F.H.A. from making, guaranteeing or insuring a mortgage in any community that has used eminent domain in this way. Eminent domain supporters say such limits would constitute a throwback to the illegal practice called redlining, when banks refused to lend in minority communities.
Unfortunately, supporters of this use of eminent domain will win that argument. It would be redlining, and it would be illegal.
…Mr. Frey said that the big banks were terrified that if eminent domain strategies became widespread, they would engulf not only primary mortgages but some $450 billion in second liens and home equity loans that are on the banks’ balance sheets. “It has nothing to do with morality or anything like that, it has to do with second liens.”
Second mortgages are the bombshell that would render the banks insolvent. Right now, the $450,000 billion in HELOCs and second mortgages have no collateral backing. If the first mortgage is condemned, these seconds are probably wiped out. Such a move would take the banks down.
.. “We’re in a bad situation,” Mr. Castillo, 44, said. “Not only me and my family, but the whole of Richmond.”
The whole of Richmond? Bullshit.
Fifty percent of the citizens who own homes are not underwater, and 40% are renters, so 70% of the citizens receive no benefit at all. The 30% who do get a break obtain a huge windfall.
As this moves forward, banks will put unlimited amounts toward lawyers to fight it. Their very survival is at stake. I hope this city has deep pockets because the cost of the lawsuits will be epic, and the worst part for the citizens of Richmond, particularly the 70% who obtain no benefit at all, is that the city will lose in the end.
$239,000 in HELOC abuse
The former owner of today’s featured property paid $470,000 on 3/26/2003. He borrowed $370,000 in a first mortgage, $47,000 in a second, and put $53,000 down. A couple years later, he took out a $200,000 HELOC, and in 2006 he refinanced with a $603,000 first mortgage and obtained a $53,000 stand-alone second. He quit paying sometime in 2010, and he was allowed to squat (or skim rent) until March of 2013.
[idx-listing mlsnumber=”IG13148860″ showpricehistory=”true”]
7512 VANTAGE Dr Huntington Beach, CA 92647
$649,900 …….. Asking Price
$470,000 ………. Purchase Price
3/26/2003 ………. Purchase Date
$179,900 ………. Gross Gain (Loss)
($51,992) ………… Commissions and Costs at 8%
$127,908 ………. Net Gain (Loss)
38.3% ………. Gross Percent Change
27.2% ………. Net Percent Change
3.1% ………… Annual Appreciation
Cost of Home Ownership
$649,900 …….. Asking Price
$129,980 ………… 20% Down Conventional
4.38% …………. Mortgage Interest Rate
30 ……………… Number of Years
$519,920 …….. Mortgage
$127,589 ………. Income Requirement
$2,597 ………… Monthly Mortgage Payment
$563 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$135 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$3,296 ………. Monthly Cash Outlays
($530) ………. Tax Savings
($700) ………. Principal Amortization
$208 ………….. Opportunity Cost of Down Payment
$182 ………….. Maintenance and Replacement Reserves
$2,456 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$7,999 ………… Furnishing and Move-In Costs at 1% + $1,500
$7,999 ………… Closing Costs at 1% + $1,500
$5,199 ………… Interest Points at 1%
$129,980 ………… Down Payment
$151,177 ………. Total Cash Costs
$37,600 ………. Emergency Cash Reserves
$188,777 ………. Total Savings Needed