Wall Street firms are directing a lawsuit aimed at blocking the city of Richmond's proposed use of eminent domain to write down mortgage loans for certain residents.
Richmond last week became the first city in the country to press forward with the controversial eminent domain mortgage plan, which has come under debate in a variety of municipalities for more than a year. San Francisco firm Mortgage Resolution Partners, which is also named as a defendant in the suit, first marketed the plan last year to San Bernardino County and two of its cities, Fontana and Ontario. The firm is now contracting with the city of Richmond to implement the strategy.
The plan would compel the sales of underwater mortgages — invoking municipal eminent domain powers, if necessary — from private investors at a discount so that a city could refinance its residents' mortgages into new loans. Richmond last week became the first city to commit itself to the plan, sending notice to the holders of more than 620 loans in the city, asking those trustees and servicers to sell the city those loans.
On Wednesday, Wall Street responded. A suit filed in federal court in Northern California by three mortgage-bond trustees asks for a preliminary injunction against Richmond and Mortgage Resolution Partners. The city's program could cause investors losses of potentially $200 million or more if the Richmond plan goes forward, the lawsuit says.
Those mortgage holders were directed to sue by Wall Street firms on behalf of their clients and other institutions, said John Ertman, a lawyer at Ropes & Gray in New York who is acting as counsel to those firms. Those firms included Newport Beach-based Pacific Investment Management Co., BlackRock Inc. of New York and DoubleLine Capital of Los Angeles.
"Mortgage Resolution Partners is threatening to seriously harm average Americans, including public pension members, other retirees and individual savers through a brazen scheme to abuse government powers for its own profit," Ertman said in a news release announcing the suit late Wednesday. "This unconstitutional application of eminent domain will be devastating for mortgage finance both public and private."
Mortgage Resolution Partners Chairman Steven Gluckstern, in a statement, said he had reviewed the suit and called it "without merit," adding that the actions by the firm and the city were "entirely within the law."
"No investor in any trust will be made worse off by the sale of any loan," he said in the statement. "Rather, it is these trustees that are wasting trust assets at the expense of America's pensioners by pursuing fruitless litigation."
Richmond Mayor Gayle McLaughlin did not immediately return a phone call seeking comment.
Eminent domain is typically used to seize land, not loans, to serve the public good, as when local governments seize blighted property or land needed for projects such as a highway. But the unorthodox plan by Mortgage Resolution Partners would use the power to force private investors to sell mortgages.
In its suit, the mortgage holders argue that the plan by Mortgage Resolution Partners violates the law on a number of grounds. The suit argues that the plan targets mortgages for a purely private use, which is a violation of the takings clause of the U.S. Constitution, the California Constitution and of eminent domain law.
By reaching beyond the city's geographic borders to take control of mortgage loans, the city also may be violating due process requirements. And, the suit argues, by rewriting mortgage contracts, the program violates the interstate commerce clause of the U.S. Constitution, likely resulting in major harm to the national mortgage and housing industries.
Also, by eradicating the debts of some local residents at the expense of out-of-state creditors, the plan would also violate the contract clause of the U.S. Constitution, the suit alleges.
"Under this scheme, 100 percent of the cost will be borne by pensioners, savers and in some cases, the taxpayers who currently own these mortgage backed securities," Ertman said in the news release. "100 percent of the profit will be split between [Mortgage Resolution Partners] and the City of Richmond."
Echoing many arguments made by major Wall Street lobbying groups, the suit argues that the consequences of the plan could mean that residents in the city of Richmond could face much higher borrowing costs.