By Marc Joffe
Richmond Police code enforcement officer Lorena Burciaga calls in a utility meter number at a... [+]
Although San Francisco Bay Area real estate prices bottomed in 2009 and are now rising rapidly, many homeowners remain underwater – owing more to their mortgage lenders than their homes are worth. One Bay Area City, Richmond, has a large concentration of such underwater homeowners; it has also seen many foreclosures and problems with neighborhood blight in the aftermath of the housing crash. Now the city has come up with a novel way to help underwater homeowners: use its power of eminent domain to condemn the mortgages and replacing them with smaller FHA loans.
This audacious attempt to provide principal reduction is the brainchild of Mortgage Resolution Partners, a private company that plans to charge $4500 to refinance each of the condemned mortgages. MRP argues that its eminent domain plan is the best way to prevent foreclosures and stabilize stressed neighborhoods.
The City kicked off its eminent domain plan in late July by sending offers on 624 underwater mortgages to the banks who service them. The banks rejected Richmond and have sought restraining orders to prevent the City from exercising its eminent domain power.
As details of the 624 mortgages Richmond selected have emerged, questions about the wisdom of the eminent domain plan have arisen. All of the mortgages were originated before 2008 and the vast majority are current. Mortgages that have been performing for six or more years rarely go into foreclosure, especially in an environment of rising home prices.
Also a number of the target homes are in affluent parts of the City – including Point Richmond, Marina Bay (which contain numerous waterfront properties) and the area near the Richmond Country Club – that are not facing blight. Foreclosed homes in these desirable areas would likely be snapped up quickly, especially in today’s hot real estate market. At least two of the homes previously sold for more than $1 million and several of the properties have over 3000 square feet of interior space – attributes not usually associated with distressed housing.
The eminent domain program is poorly targeted because it is tailored to the revenue requirements of MRP rather than to the public good. An initiative truly aimed at alleviating blight would focus strictly on homes in poorer neighborhoods with high concentrations of foreclosures and would include more at-risk borrowers. Unfortunately, such homeowners are less likely to qualify for an FHA mortgage due to their credit histories, and their lower priced properties generate less revenue for MRP and the City to share.
The City might also consider other policies to address underwater mortgages. According to Zillow, Richmond has lower average home prices than neighboring Albany and El Cerrito; it is also seeing slower property appreciation. If Richmond home values were to catch up with those in adjacent cities, fewer homeowners would remain underwater. To this end, city leaders should be concerned with reducing crime rates, encouraging new development and improving neighborhood schools rather than exploring the limits of their eminent domain power.
Aside from being an inefficient way to help struggling neighborhoods, MRP’s eminent domain scheme has a number of downsides. First, it harms investors in Residential Mortgage Backed Securities (RMBS). Although Richmond Mayor Gayle McLaughlin has portrayed this issue as a conflict between homeowners and banks, the fact is that banks do not own most of these securities. Indeed, a large portion of RMBS are owned by public employee pension funds such as CalPERS. Losses inflicted on RMBS owners will thus place more pressure on states and local governments trying to keep up with rising employee pension costs. Other significant holders of RMBS are Fannie Mae, Freddie Mac and university endowments, which means that this use of eminent domain would also be detrimental to federal taxpayers and college students.
By further increasing the risk of private RMBS, the application of eminent domain to residential mortgages might destroy demand for these securities. RMBS investors took severe losses in 2007 and 2008, leading to a freezing of the market. In 2010, Redwood Trust – a Mill Valley, California financial firm – began securitizing residential mortgages again. In the last two years, their program has picked up substantial momentum and other issuers have rejoined the market.
Since banks rarely hold onto mortgages they issue, private residential mortgage securitizations are the only serious alternative to government backed housing finance. During the financial crisis, taxpayers were asked to bail out Fannie Mae and Freddie Mac at a cost of over $187 billion. To avoid a repeat of this situation, President Obama has joined both Congressional Democrats and Republicans in calling for the phase out of these two government sponsored enterprises. If the market for private RMBS freezes because of uncertainty over cities’ use of eminent domain, there will be no credible alternative to government backed mortgages. While such an outcome may initially seem attractive to Progressives, it is worth pondering the social justice aspects of asking working class taxpayers to subsidize the interest rates on $600,000+ mortgages – because that is part of today’s housing finance system.
Finally, if Richmond and MRP win this case, they will set an important legal precedent extending the power of eminent domain. The takings clause of the Fifth Amendment has traditionally limited the use of eminent domain to public purposes – like obtaining right of way for a new transit line. In Kelo vs. The City of New London, the Supreme Court permitted a city to condemn an individual’s home for the benefit of a private developer. In this case, the primary beneficiaries are private citizens who have negative home equity. The City and MRP will argue that benefiting certain individuals through condemnation will serve the public good by reducing blight – but as we have already seen their plan is an inefficient means of achieving that end. A decision in their favor may provide grounds for other public agencies to explore further extensions of this very dangerous power.
Marc Joffe is Principal Consultant at Public Sector Credit Solutions. In 2012, he co-authored a study for the Reason Foundation entitled Restoring Trust in Mortgage Backed Securities, with Anthony Randazzo.
