While one can have sympathy for the over-levered, underwater homeowners that took free-money with both hands and feet as house prices surged in the mid-2000s (just like they are now) but the latest moves to 'save' people from themselves in the city of Richmond, CA is raising both market and constitutional concerns. As NYTimes reports, the city is the first to use eminent domain by the local government (in partnership with a 'friendly' mortgage provider) to seize homes, force investors to take a loss on the mortgages, re-issue a new 'lower' mortgage, and allow the homeowner back with positive equity (ready to lever-it-back-up into a new Harley). As Guggenheim notes, this is likely to hurt supply of new mortgages and as we noted previously (here and here), it seems clear that private-label MBS holders will not be happy, consumers hurt as mortgage costs would rise (this 'risk' has to be priced in), and taxpayers unhappy as this is yet another transfer payment scheme to bailout underwater loans.
Where are all the underwater homes?
The power of eminent domain has traditionally worked against homeowners, who can be forced to sell their property to make way for a new highway or shopping mall. But now the working-class city of Richmond, Calif., hopes to use the same legal tool to help people stay right where they are.
On Monday, the city sent a round of letters to the owners and servicers of the loans, offering to buy 626 underwater loans. In some cases, the homeowner is already behind on the payments. Others are considered to be at risk of default, mainly because home values have fallen so much that the homeowner has little incentive to keep paying.
Many cities, particularly those where minority residents were steered into predatory loans, face a situation similar to that in Richmond, which is largely black and Hispanic.
Richmond is offering to buy both current and delinquent loans. To defend against the charge that irresponsible homeowners who used their homes as A.T.M.’s are being helped at the expense of investors, the first pool of 626 loans does not include any homes with large second mortgages, said Steven M. Gluckstern, the chairman of Mortgage Resolution Partners.
[How It Works]
The city is offering to buy the loans at what it considers the fair market value. In a hypothetical example, a home mortgaged for $400,000 is now worth $200,000. The city plans to buy the loan for $160,000, or about 80 percent of the value of the home, a discount that factors in the risk of default.
Then, the city would write down the debt to $190,000 and allow the homeowner to refinance at the new amount, probably through a government program. The $30,000 difference goes to the city, the investors who put up the money to buy the loan, closing costs and M.R.P. The homeowner would go from owing twice what the home is worth to having $10,000 in equity.
All of the loans in question are tied up in what are called private label securities, meaning they were bundled and sold to private investors.
About two dozen other local and state governments, including Newark, Seattle and a handful of cities in California, are looking at the eminent domain strategy, according to a count by Robert Hockett, a Cornell University law professor and one of the plan’s chief proponents.
“This is not the first choice, but it’s rapidly becoming the only choice on how to fix this mess,” said William Frey, an investor advocate.
Mr. Frey said that the big banks were terrified that if eminent domain strategies became widespread, they would engulf not only primary mortgages but some $450 billion in second liens and home equity loans that are on the banks’ balance sheets. “It has nothing to do with morality or anything like that, it has to do with second liens.”