Insights

For the past three months, the eyes of mortgage lenders, servicers, and their constituents have been focused on the City of Richmond, California, and its controversial plan to assist its residents in restructuring underwater mortgages. The success of this plan will have a far-reaching impact on mortgage lending nation-wide.

Eminent domain, which is the inherent power of a governmental entity to take privately owned property and convert it to public use, subject to reasonable compensation for the taking,¹ is central to plan. Ironically, this legal authority that has traditionally been used by governments and municipalities to take property from a private land owner is now being used to help private landowners remain in their homes.

The Plan

In June, the mayor of Richmond, Gayle McLaughlin, announced that her city would participate in an organized effort to keep homeowners out of foreclosure by seizing underwater mortgages via eminent domain.  The city has partnered with Mortgage Resolution Partners, LLC (MRP), a San Francisco-based investment firm, to provide financial backing for the endeavor.  The plan, which is described in greater detail below, is in its initial stages at this time. 

Under the plan, the city and MRP have identified certain residential properties that are deemed to be worth significantly less than the amounts that are mortgaged against them.  Of the properties that were identified, MRP will extend offers to the mortgage holders to purchase the loans secured by these properties for an amount that MRP considers to be fair market value.  Under the current plan guidelines, the amount offered will be about 80 percent of the current value of the home.  If the mortgage holder refuses the offer, the city will exercise eminent domain powers and force the mortgage holder to sell its loan for the amount offered by MRP.  The city will then write down the debt to 95 percent of the current value of the home.  The homeowner will be allowed to refinance the home with a new lender.²  

As an example, consider a home that is mortgaged for $300,000 but has a current market value of $200,000.  The offer made to or forced upon the mortgage holder would be for $160,000 (80% of the current value of the home).  The city would then write down the debt to $190,000 (95% of the value of the home).  The homeowner would refinance the home for the amount of $190,000.  The $30,000 difference between the amount paid by MRP to the original mortgage holder and the amount for which the property is refinanced ($190,000 - $160,000) would go to the city and MRP.  And the homeowner would go from having an underwater property to having $10,000 in equity.
 
It is noteworthy that 444 of the 624 loans for which offers have been extended at this point are not currently in default.³ 

The Justification

Proponents of the plan contend that such a drastic measure is necessary in order to reduce blight and associated costs within the city.  Some supporters also claim that the plan is needed to redress wrongs promulgated by predatory lenders that targeted certain minorities who were eligible for conventional mortgages but steered them into loans with higher interest rates and ballooning payments.

Those in support of the plan, led by Richmond Mayor McLaughlin, are passionate and confident that they are in the right.  John Vlahoplus, a chief strategy officer for MRP, stated that, "The city is acting to protect itself and its residents – not to stick it to the man, or because of moral judgments about the borrower who took out the loan or the lender who originated it.  Anyone who cannot recognize the fundamental public purpose of reducing harm to the community is morally blind."⁴

Richmond relies upon the U.S. Supreme Court's 2005 decision in the case Kelo v. New London⁵ for support that its prospective use of eminent domain is proper.  In Kelo, the Court determined that governments could assert eminent domain authority for economic development, including taking property and transferring it to another private owner as long as they pay for it.  Some constitutional scholars have commented 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."⁶  

The Opposition

Opposition to the Richmond plan is abundant.  Mortgage lenders are naturally upset because of potentially billions of dollars of losses on primary mortgages and secondary home equity liens that could ensue if the strategies adopted by the plan become widespread.   The plan's opponents, which include mortgage lenders, institutional investors, the Federal Housing Finance Agency, GSE's, and various mortgage lending trade associations, are mounting a furious attack to stop it in its tracks.

A main argument by the opposition is that the plan is unconstitutional in that it violates the "contracts" clause and the just-compensation requirements of the "takings" clause in both the U.S. and California constitutions.  Further, opponents maintain that the plan will ultimately harm borrowers by chilling lending in areas in which these eminent domain strategies are implemented.  They believe that the city's plan will ultimately result in long-term negative consequences for borrowers residing in or seeking to purchase property in the area, including: lower loan-to-value ratios, higher interest rates, higher loan origination costs, diminished access to credit, fewer individuals qualifying for loans, and declining home values.

It is also contended that the plan is designed solely to enrich the city and MRP at the expense of not only the mortgage lending industry but average citizens who are beneficiaries to pensions or who invest in mutual funds.  Many of the loans that have been or will be attacked are bundled in mortgage-backed securities. It is estimated that if the Richmond plan is permitted to be carried out, it will result in losses of up to $200 million for investors in residential mortgage-backed securitization trusts. The losses would be multiplied exceedingly if similar plans are implemented in municipalities across the country.⁷

Where It Will Go From Here

So far, two mortgage lenders, Wells Fargo and Deutsche Bank, have filed suit on behalf of their investors seeking to enjoin the city and MRP from moving forward with the eminent domain portion of its plan.⁸  Additionally, multiple federal government agencies have issued statements strongly denouncing the plan.⁹  It is likely that the issues brought about by the Richmond plan will be tied up in the court system for years. 

Despite the adversity, it does not appear that Richmond and MRP will be backing down any time soon.  On Tuesday, September 10th, the Richmond City Council voted 4-3 to continue with its initiative to use eminent domain powers to restructure underwater mortgages.¹⁰  Meanwhile, other U.S. cities that were considering similar plans are now backing off.  The city council of North Las Vegas, Nevada voted 5-0 earlier this month against the plan presented to it by MRP.¹¹  It is unlikely that any other cities will look to implement an eminent domain strategy at this time, at least until the Richmond cases are decided. 

For the Richmond, CA residents that this plan was supposed to help…they are the worst off at this time.  Until the matter is resolved, lenders will be leery to finance any residential real estate transactions in this area.  This will keep Richmond home values low while values in many of the other areas of the country are on the mend.

¹ BLACK'S LAW DICTIONARY 541 (7th ed. 1999).
² Shaila Dewan, A City Invokes Seizure Laws to Save Homes, N.Y. TIMES, July 29, 2013; Nick Timiraos and Jeannette Neumann, Richmond's Seizure Plan Complicated by Size of Mortgages, WALL ST. J., August 15, 2013.
³ Jody Shenn and John Gittelsohn, Eminent Domain Battle Pits Homeowner Against Hospital, BLOOMBERG NEWS, August 1, 2013.
⁴ Nick Timiraos and Jeannette Neumann, Richmond’s Seizure Plan Complicated by Size of Mortgages, WALL ST. J., August 15, 2013.
⁵ Susette Kelo v. City of New London, Connecticut, 545 U.S. 469 (2005).
⁶ Shaila Dewan, A City Invokes Seizure Laws to Save Homes, N.Y. TIMES, July 29, 2013
⁷ Jeff Sistrunk, Banking Giants Sue Calif. City Over Mortgage Seizure Plan, LAW 360, August 7, 2013, http://www.law360.com.
⁸ Id.
⁹ Jacob Gaffney, Freddie Mac explores eminent domain options, HOUSINGWIRE, August 7, 2013, http://www.housingwire.com; Kerri Ann Panchuk, Eminent domain debate turns the mortgage industry libertarian, HOUSINGWIRE, August 8, 2013, http://www.housingwire.com; Author unknown, HUD doubts eminent domain strategy, HOUSINGWIRE, August 14, 2013, http://www.housingwire.com.
¹⁰ Megan Hopkins, Richmond City Council votes to move forward with eminent domain, HOUSINGWIRE, September 10, 2013, http://www.housingwire.com.
¹¹ Jim Christie, Nevada city rejects eminent domain plan for mortgages, REUTERS, September 4, 2013.