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Last month, Richmond, California, a city just north of Berkeley where about half of all homeowners are underwater, controversially proposed using eminent domain laws to buy or seize mortgages for less than the value of the home, refinance them, and sell them back at a level the homeowner can afford. The mortgage finance industry, not terribly fond of taking what amount to forced principal reductions on mortgages, has filed suit to keep Richmond from enacting this plan.
While Richmond is trying to be the first city to attempt this rather unique solution, it’s not a new idea. The idea was pushed by Cornell finance law professor Robert Hockett in a July 2012 paper, and floated, in a slightly different way, back in 2008 by Harvard Law professor Howell Jackson. San Bernadino County, in Southern California, floated the idea shortly afterward, only to quickly back down after the mortgage industry threatened to sue. North Las Vegas has also been considering using eminent domain, and just approved a plan similar to Richmond’s earlier this week. Several cities in New Jersey are considering it as well.
The catalyst behind all of these municipal plans has been Mortgage Resolution Partners, a private investment firm that intends to help finance the mortgage buyouts (and reap the profits once they are resold). MRP thinks the bondholders should be happy about this plan, because “the loss for many bondholders has already been baked into this”.
The lawsuit, brought by Wells Fargo and Deutsche Bank, contends that the plan will enrich Richmond, MRP, and the homeowners at the expense of the mortgage owners and thus violates “the constitutional requirement of ‘just compensation’ for any taking” under eminent domain law. The American Bankers Association and credit union trade groups are also against the plan, writing to Congress this week in an attempt to get the legislature to block the tactic. “The impact will be a significant contraction of credit availability”, writes ABA senior economist Keith Leggett.
Bill McBride says the plan “seemed like such a dumb idea I didn’t expect it to go anywhere.” Matt Levine, meanwhile, explains that the question at the heart of this is how much the mortgages are really worth:
What do the mortgage investors deserve to be compensated for: their rights under the mortgage contract, which are basically “the house or the mortgage, whichever is less,” or their expectations based on the world as it currently exists, where performing underwater mortgages trade above the collateral value because everyone knows that those borrowers aren’t just going to walk away from their mortgage?
– Shane Ferro
On to today’s links: