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California

Steven Greenhut
Eminent Scam
A plan to rescue some Californians from possible foreclosure sets a dangerous precedent.
12 September 2013

When the housing bubble began deflating in 2007, California’s high-flying real-estate market crashed especially hard. Six years on, some cities still struggle with how to handle vacant houses and residents who owe far more than their properties are worth. Today’s “underwater-mortgage” problem was largely the creation of government policies that promoted easy lending practices on the one hand, while imposing strict land-use rules—thus reducing the affordable-housing supply—on the other. Now a new plan would only compound the folly, at least in the Bay Area city of Richmond, where officials seeking to boost the local housing market propose to take mortgages from private lenders through eminent domain.

Richmond’s scheme, affirmed by a city council vote this week, is the brainchild of Mortgage Resolution Partners, a group of private investors with close ties to the state Democratic Party. The San Francisco-based firm sold the plan to city officials as an act of altruism to help hard-pressed homeowners get back on their feet. “America is experiencing an historic national mortgage crisis,” MRP explains on its website. “Due to a collapse of home values, one in five mortgaged homeowners owe more than their homes are worth; more than 11 million families are now underwater. Nearly 3 million of these families are in default and on their way to foreclosures that will depress home prices further, causing still more foreclosures. MRP seeks to stem this tide.” Well, that’s not quite all MRP seeks.

The city has already sent letters to various banks concerning 624 houses, offering to pay the lenders about 20 percent below the homes’ estimated market value. MRP would then refinance each of the mortgages at the market rate for a $4,500 fee. Homeowners would get to stay in their homes with a new monthly payment set at the lower principal, the city wouldn’t have to worry about losing more tax revenue, MRP would make a tidy profit—and the original lenders would get stiffed. (The plan excludes mortgages held by the Federal Housing Authority, as well as the taxpayer-financed Fannie Mae and Freddie Mac.)

In traditional eminent-domain proceedings, the government says that it needs a piece of private property for some public purpose—usually to build a school or a road. In recent decades, “public purpose” has come to mean giving private property to a private developer to build a shopping mall or a hotel. Government officials justify these “takings” as ways to enhance tax revenue, and the courts have gone along. Richmond officials argue that their plan would reduce urban blight. But as the San Francisco Chronicle recently reported, Richmond’s plan would include seizing the mortgages of at least two homes purchased for over $1 million, “a revelation that appears to undermine the city’s argument that the plan would combat blight.” The Chronicle ran a photo of a home that sold for $1.2 million, has a loan balance of nearly $900,000, and is valued at $666,000. The city would pay just $510,000 for the loan.

What kind of bondholder or lender would willingly sell his property at 20 percent below market? None in his right mind, without the threat of eminent domain. Predictably, bondholders and lenders—including Wells Fargo Bank—have taken Richmond to court. Last month, lawyers for the city asked a federal court to throw out the lenders’ lawsuits, which allege that the city’s plan violates the constitutional requirement that governments pay just compensation for taken property. Two weeks earlier, Richmond’s mayor and other elected city officials showed up unannounced at Wells Fargo’s headquarters in San Francisco demanding that the bank drop its complaint. A security guard turned them away. Meantime, lieutenant governor Gavin Newsom, a Democrat and former mayor of San Francisco, has threatened to investigate mortgage firms that want to pull out of communities adopting MRP’s eminent-domain plan. Newsom, the Chronicle reported, has close ties to an MRP partner and received a $25,000 campaign donation from an MRP officer.

What Newsom and Richmond officials won’t, or can’t, acknowledge is that the problem of underwater mortgages appears to be working itself out without additional government meddling. Richmond may not be the toniest city in the Bay Area, but its home prices grew by about 11 percent last year. Prices around the region remain among the highest in the country, and they’re even rebounding in the Central Valley and San Bernardino and Riverside counties, which were among the worst affected by the crash.

Why would it not be in Richmond’s interest to acknowledge this good news? Typically, when cities employ eminent domain for the purpose of economic development, they use a strategy called “growth capture.” Though officials claim that eminent domain is reserved for downtrodden neighborhoods, they tend to focus on areas where property values are just starting to rise. That way, the city can capture the coming growth in sales and property-tax revenues while developers make a nice profit. Richmond officials and MRP appear to be looking for a windfall at the precise moment the housing crisis has passed.

The banks rightly fear that if Richmond succeeds, the practice could spread. Last year, San Bernardino County and two cities, Fontana and Ontario, rebuffed MRP’s overtures. But other cities in California and Nevada are weighing essentially the same proposal, meaning that whatever happens in Richmond has statewide and even national implications. In short, MRP is using government to execute a business transaction that could otherwise never happen in a free market. Richmond and MRP will set a terrible precedent if they succeed.

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