Housing fix has strong enemies
One way to judge the virtues of the city of Richmond’s initiative to use eminent domain to help its strapped mortgage borrowers is by the hysterical reaction of the banks and investors holding the mortgage loans.
Wells Fargo & Co. and Bank of New York have sued the East Bay city in federal court to throttle the plan even before its birth. (A court hearing on their request for an injunction is set for Sept. 13.)
They’ve enlisted federal regulators in their hand-wringing over the damage little Richmond (pop. 105,000) might wreak on the mortgage market nationwide. The real estate interests have even cajoled some of their housebroken congressmen, such as John Campbell (R-Irvine), into introducing legislation to stop Richmond in its tracks.
So there must be something to the city’s idea.
A lot of flapdoodle has been pumped into the public consciousness about Richmond’s plans, most of it from the financial sector. It says Richmond is planning to seize underwater mortgages from lenders by condemning them by eminent domain for low-ball prices. It says there’s no precedent for using eminent domain for the city’s stated purpose of arresting blight — it’s just for building things like schoolhouses and highway onramps. This is all about “the misuse of public power for private benefit,” to quote Bank of New York’s lawsuit.
But that’s not quite true. It’s really all about the failure of the federal government and the banking industry to bring desperately needed mortgage relief to homeowners wrecked on the shoals of the housing crash — many of them steered onto the rocks by unscrupulous mortgage bankers.
The government’s major program for mortgage relief, the Home Affordable Modification Program, has served only 20% to 25% of the 5 million homeowners it was designed to assist. Richmond is stepping into a genuine vacuum.
It’s also about arresting a slide in Richmond’s economy. “I want to stabilize our neighborhoods,” says Patrick Lynch, the city’s housing director. “I know what a blighted property costs us to board it up and send the fire department out on calls.”
You may think Richmond’s effort is outdated. After all, home values are rising again and the foreclosure wave is ebbing. That’s true generally, but the trend has passed Richmond by. In the city, which is 40% Latino and 25% black, more than half the homeowners are still underwater — their homes are worth less than they owe on their mortgages — by an average of 45%.
Richmond’s goal is to bring some financial relief to those homeowners. They’re prime candidates for relief, because the deeper underwater a loan is, the greater the chance that it will end up in default and then foreclosure.
It’s well understood in the housing industry that the most effective way of staving off these defaults is to cut the principal due on the loans to a figure bearing some rational relationship to the home’s value.
The toughest mortgages to work out, according to Richmond officials and their financial advisors, are those held in securitized pools, which can be owned by hundreds of thousands of investors; banks that service those pools tend to be uncertain about their legal authority to modify those mortgages unless they’re right on the verge of foreclosure, so they tend not to be proactive.
So Richmond’s City Council voted to offer banks servicing mortgage pools a deal: The city would buy underwater mortgages. Then, with the help of the San Francisco investment firm Mortgage Resolution Partners, the mortgages would be extinguished and refinanced so their balances would come to about 95% of the homes’ current market value, on average. They’d no longer be underwater, and the risk of default would be much lower.
The targeted loans should meet two criteria, according to Robert Hockett, a Cornell University law professor who originated the idea of backing up mortgage refinancings with eminent domain. They should be loans so deeply underwater they’re at high risk of default, “so their value can actually be increased by writing down the principal balances,” he told me. Second, they should be loans that are hard to write down voluntarily, because of the questions about the loan servicers’ authority to do so.
The city’s eminent domain power plays a dual role in this initiative. First, it’s a threat: If the banks refused to deal with the city, the mortgages could be seized. But it’s also a tool: It removes all legal doubt about the banks’ authority to sell or modify the loans; they would be required to do it.
Richmond started the ball rolling July 31 by making an offer to Wells Fargo and other servicing banks for 624 loans with unpaid balances totaling about $242 million. More than two-thirds had the oddball features that made for toxic loans during the housing crash — adjustable rates, negative amortization, interest-only payments.
The city’s offer came to $126.5 million, or a little over 52% of the unpaid balances. “The prices being offered for these loans are wildly low-ball numbers, points and points and points below fair value in this market,” says Daniel Ivascyn, head of the mortgage portfolio team at the Newport Beach investment firm PIMCO, which owns some of the mortgage pools at issue and is pressing for the injunction. That said, the mortgages sought by the city average out at 37% underwater. That’s a level at which the risk of default is high, even if they’re not yet delinquent.
Here are some important points: The city made clear these were opening bids — it invited the banks to counter “if for any reason you are not satisfied with this offer.” Second, a true low-ball offer wouldn’t survive the eminent domain process, because under state law, the owner of seized property can demand a reappraisal from a court. Third, the city hasn’t actually started any eminent domain proceedings — that will require a separate vote by the City Council. In other words, the banks have gone to court to stop a program that doesn’t actually exist yet.
The mortgage industry has responded to Richmond with all the fatuous flimflam you would expect from a gang that has never owned up to its responsibility for the housing disaster.
In a declaration filed with the Wells Fargo lawsuit, Mortgage Bankers Assn. Chief Executive David Stevens characterizes the typical mortgage contract as a homeowner’s “unconditional promise” to repay the loan in full, “regardless of the future value of the house or any other set of circumstances.” His point is that using eminent domain interferes with this sacred relationship.
There are only two possible interpretations of this statement: Stevens is either shockingly ignorant, or he’s lying. The truth is that there’s nothing “unconditional” about a mortgagee’s obligations. Homeowners can always walk away from the loan, on condition they’re prepared to give up their home to the lender, suffer a hit to their credit rating, and in some states be sued for other assets. California is not one of those states: If a borrower defaults on an original mortgage to purchase a house, whether inadvertently or deliberately, the lender can take the home, and that’s all. (As of this year, that protection extends to many refinancings, too.)
The idea that homeowners should spend their way to poverty or death to keep up the mortgage is a fiction concocted by the mortgage industry to protect itself and discourage homeowners from considering their own financial interest when their homes are deeply underwater.
The plaintiffs call the proposed use of eminent domain unconstitutional, although the Supreme Court has ruled in the past that intangible property such as mortgage contracts can be seized, and (in 2005) that seizing private property and handing it over to private entities is legal if it promotes economic development.
In any case, that sounds like a question to be resolved in court after Richmond actually seizes a mortgage, not before. But the real purpose of the lawsuits may be to intimidate other municipalities considering the eminent domain scheme, by showing that they’ll be tied up in legal fees.
The banks argue that the Richmond initiative is unnecessary because they already do their utmost to reach out to struggling homeowners. This is according to a declaration by investment banker Philip Burnaman, also filed by Wells Fargo. Burnaman states that the banks “go to great lengths” to reach out to troubled borrowers and “attempt ... to modify the terms of the loan in order to increase its affordability.”
This may be true, in fairyland. In the real world, banks haven’t done nearly enough along these lines. Rather, they’ve engaged in all sorts of abuses of strapped borrowers, including improper foreclosures.
That’s why five major banks — including Wells Fargo, which is suing Richmond — last year signed a $25-billion settlement with federal and state officials to stave off criminal prosecution. And just three weeks ago a federal appeals court in San Francisco whacked Wells Fargo — there’s that name again — for what one of the judges labeled its “fraudulent” treatment of a borrower seeking a loan modification. The judges overturned a lower court ruling in the bank’s favor and sent the case back down for trial.
Some investors observe that servicers of securitized mortgages have been doing better for strapped homeowners in recent years. “Three or four years ago there would have been a better case” that securitized mortgages weren’t getting needed modifications, Ivascyn says. In fact, of the 624 loans Richmond wants to buy, more than half have already been modified at least once, including 40 that already have had principal write-downs. So it’s not as if the banks have done nothing.
Richmond’s point is they haven’t done enough. In its lawsuit, the Bank of New York grouses that the city’s offers are too low even to be “the beginning of a constructive negotiation.” If that’s so, the banks should call the city’s bluff: Sit down and negotiate.