August 4, 2013

The First Rule Of Lifesaving

A reader suggested a topic on eminent domain. “Several California cities (most recently Richmond, CA.) have proposed using eminent domain to seize and restructure blocks of underwater houses then sell them back to the mortgagees at fair market value (minus a percentage incentive to the banks or bondholders).”

“Potentially 3+ million mortgages nationwide could be rewritten in this manner, with investors putting up the money in exchange for a bundled percentage of the cram-down. So far it’s not come to fruition, but with housing bubble bust #2 looming, is this an idea whose time has come? What better way to hedge all those REITs than to co-opt the city councils of about-to-bankrupt municipalities?”

US News and World Report. “A city of about 100,000 people on the outer shores of San Francisco Bay, Richmond has been left behind by the economic recovery. Roughly half the home mortgages there are underwater and many are worth less than half of what is owed on them. Vacant and foreclosed properties blight the city, a largely black and Hispanic community.”

“Banks have dragged their feet in restructuring the underwater mortgages. So this week, Richmond invoked the threat of eminent domain to break the deadlock. The city wrote to 32 lenders offering to buy 624 homes at prices close to current market value, but far less than the outstanding loans. This would force the lenders to write off the balance as a loss. The city is threatening to use eminent domain to take possession of the loans and the homes if the banks don’t accept the city’s offer or negotiate a mutually acceptable counter-offer.”

“Once the city has bought the homes – whether by agreement or through eminent domain – it plans to restructure the mortgages so the present occupants can stay in them. The loans will be reset to a price close to current market value, and the payments will be reduced accordingly. Homeowners, instead of being underwater, will now have a small amount of equity in the property. They will have both the means and the incentive to stay current on the loan going forward.”

“The banking and real estate industry spokespeople say that governments have no right to step into a private transaction between a borrower and lender. But objectively, it’s hard to see why bailing out homeowners with a program of this sort is any less an affront to the principles of capitalism than bailing out banks that made bad investments in mortgage backed derivatives.”

“Both sides have a point. If eminent domain were used too freely, it would in effect give borrowers a ‘get out of jail free’ card that would encourage unhealthy speculation. It would also shift the economics for lenders, raising the cost of credit. On the other hand, the present situation is bad for communities, bad for borrowers and, frankly, it’s bad for many lenders.”

From Bloomberg. “Richmond has 4,600 underwater mortgages. It sent purchase offers this week to the owners of several hundred. Just wait till some nosy gadfly or enterprising journalist figures out that some of those borrowers are friends, relatives or patrons of local politicians — or on the city’s payroll themselves. It’s bound to happen, if not in Richmond then in other municipalities that try to follow its example. Then picture the recriminations as folks figure out who scratched whose back in exchange for getting their principal balance reduced by tens or hundreds of thousands of dollars. This could be the biggest wealth creator to hit some small towns since the invention of roadside speed traps.”

“Imagine what would ensue if a program like this were tried in some ethically challenged city such as New Orleans or Miami. Or Hoboken, New Jersey, the town I call home, where two of the last four mayors have gone to prison for taking bribes. Where I live, it’s amazing what people have managed to accomplish with brown paper bags of cash and by knowing the right people.”

“Cities usually use eminent domain to seize land and buildings. If they’re going to start seizing home mortgages, why stop there? In some states cars are subject to local property taxes. Why not seize auto loans, in the name of economic development and promoting the public good? Maybe next they could go for people’s past-due credit-card debt. How could anyone stand by idly and not help local voters who are deemed deserving, right? Then watch city officials complain when banks charge all of their constituents more money for credit because of their ZIP code.”

The Times Argus. “Ordinarily, those with money and power use eminent domain to advance their interests, in the name of the community. In this case, those without power, except the power that inherently belongs to the people, would use it to seize mortgages from those who are holding the community in debt bondage.”

“The burden of debt continues to create enormous disequilibrium within the economy and society. People are burdened with mortgage debt, student loan debt, credit card debt. Often the debt piled up as a result of predatory lending or as a result of efforts merely to keep up. Sometimes debt was incurred irresponsibly — for example, by speculators hoping to churn real estate or by people out of their depth.”

“The effect of debt is to make people slaves to their creditors. The creditors are happy to continue taking our money, which is why they are opposing Richmond’s eminent domain scheme. And yet in numerous ways across the country communities are taking steps to reclaim their destiny from predatory institutions. Vermont’s health care initiatives fall into that category. Fostering of a local food economy serves the goal of gaining independence from big agriculture. Let’s cheer Richmond’s efforts to give the banks some of their own medicine and to force them to share in the misery they have been complicit in creating.”

Nevada Business. “San Francisco-based Mortgage Resolution Partners (MRP) has been pitching a scheme to get distressed cities to use their right of eminent domain to seize underwater homes and pay MRP to help restructure the mortgages. They tried and failed in several cities before finding a receptive audience in North Las Vegas. Under their plan, MRP would identify homeowners who are underwater yet still current on payments, and whose mortgages were financed by private investors and bundled into mortgage-backed securities. Using its power of eminent domain, the city would forcibly take over the properties and pay the current mortgage holders pennies on the dollar.”

“The city could then re-sell the homes back to their current owners at a price closer to market value, assuming the owners could qualify for a new loan. MRP estimates about 5,000 homes in North Las Vegas would qualify for their plan.”

“As an example, the city takes over a home with a $300,000 note and pays the original mortgage holder only $150,000. Then MRP finds a buyer for a new note at $190,000. Theoretically, the city would make $40,000 (less fees) and the homeowner’s mortgage is now $190,000 instead of $300,000. But what about the holder of the original note? In effect, the city is using its power of eminent domain to take $150,000 away from that investor. These mortgage-backed securities are owned by everyday citizens who have put their savings into investment funds. Why should they lose their investment in order to benefit the underwater homeowner, the city government and MRP?”

“This ‘feel-good’ proposal is wrong on so many levels. Implementing the plan could be costly and carries a lot of risk. Investors who currently hold mortgages could sue the city, which could be responsible for court costs. This plan would have repercussions for the entire area by making private lenders unwilling to make loans here. And proposed legislation in Congress would bar federally backed loans in any county where eminent domain is used for mortgage relief.”

“The agreement with MRP contains a clause allowing the city to back out of the agreement at any time. When the City Council meets on August 21 it should cancel the contract before it gets in any further trouble. While we feel for the people who are stuck in underwater homes, the first rule of lifesaving is not to let the drowning person pull you under, and this is just what’s likely to happen if North Las Vegas continues with this unconstitutional and dangerous scheme.”

Bits Bucket for August 4, 2013

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