Eminent domain is the taking of private property by the government to advance a public purpose. The property owners must be given the market value (as best it can be determined), but they have no choice in the sale. For example, if a city is building a flood control project, and one of the fifty property owners involved refuses to sell, the city can force the sale in order to make the project happen. No single property owner can hold the community hostage. Eminent domain can’t be invoked for just anything, however, and governments have lost in court when there were other options available to them, when they didn’t pay enough compensation, or when the project wasn’t important enough to merit such a taking.
If you don’t know much about eminent domain, you’re about to learn, thanks to the city of Richmond, California.
Richmond is a working class town on the east side of the San Francisco Bay, mostly African-American and Hispanic, whose residents have incomes and educational levels below the California state average and higher than average poverty levels (Census figures here). Oh, and they’ve got a big problem with underwater mortgages. Residents of Richmond say that they have tried, without success, to have their mortgages adjusted. City officials are worried that walk-aways or foreclosures will devastate an already struggling area, and have decided to enter the fray.
Richmond, working with Mortgage Resolution Partners, has offered to purchase 624 mortgages that are seriously underwater, and has threatened to force the sales by invoking eminent domain. They would then rework the terms of the loans to match the current property value (with MRP doing the financing), and set the homeowners back up in their own homes.
As you might guess, the banks are not thrilled with this. The purchase offers are based on the actual value of the properties, which is at a discount compared with the paper values, and the banks don’t want to give that up. Also, banks are used to doing the seizing, not being seized themselves. Worst of all, what will happen when word gets around to other cities who are in the same boat?
With approval from Fannie Mae and Freddie Mac, various banks that service and/or own these loans have filed suit, joined by investment firms like PIMCO, and BlackRock. The Federal Housing Finance Agency (Fannie and Freddie’s regulator) filed a notice in the Federal Register [pdf] last year when this approach first began to be raised, noting their concerns and opposition to what Richmond is doing:
Among questions raised regarding the proposed use of eminent domain are the constitutionality of such use; the application of federal and state consumer protection laws; the effects on holders of existing securities; the impact on millions of negotiated and performing mortgage contracts; the role of courts in administering or overseeing such a program, including available judicial resources; fees and costs attendant to such programs; and, in particular, critical issues surrounding the valuation by local governments of complex contractual arrangements that are traded in national and international markets.
Note, please, that FHFA’s mission is to protect Fannie and Freddie, and through them, the secondary mortgage market. It’s not to protect consumers from predatory mortgage practices or communities from being devastated by rapacious financial industry folks. As the LA Times noted, Fannie et al. are bothered by the use of eminent domain because it might hurt their bottom line:
The use of eminent domain is “a serious issue that has the potential to unsettle investors in mortgage securities,” Fannie Mae Chief Executive Timothy J. Mayopoulos said Thursday.
Um, that’s kind of the point. Eminent domain has done what nothing else — including federal so-called regulators — has managed to do: get their attention.
Now things turn to the courts, and this is where things get very, very interesting. If the banks and investment community were unsettled by the threat of eminent domain, they’re going to love what happens next: discovery.
That one little word is the key to this whole fight, from the standpoint of Richmond. That’s the process by which Richmond’s lawyers can demand that the banks and investment firms turn over evidence and submit their officers and employees for questions under oath. In other words, they have to open their books.
That’s not going to make the banks happy at all.
For starters, I’d expect Richmond to force the bondholders to prove they have standing, by requiring them to provide proof that they hold the mortgage. They’ll demand that they turn over the whole MERS chain of ownership, and demand that each step in the ownership chain be proven. (Got any robosigned documents in those files?) But that’s just for starters.
The overall structure of Richmond’s eminent domain argument is pretty straightforward:
(1) These overinflated mortgages have caused significant portions of the city to become potentially blighted and pose serious problems to the city if the banks foreclose on them — or even if they merely threaten to foreclose — and the owners of the property move out. [See “Detroit”]
(2) The homeowners have tried repeatedly — without success — to rework the mortgages, both with the banks who service the loans and through various federal programs, but the incentives to the servicer banks are to prolong the process, not to refinance/rework the loan, and so they delay and deny relief, while investors in RMBSs are similarly disinclined to take a haircut on their paper profits.
(3) The City of Richmond, therefore, is left as the agent of last resort, and is taking this action to preserve the city itself.
This is where things the lawyers for Richmond will have fun as they conduct their discovery. The banks, Freddie, and Fannie want their money on these loans, but they also want to keep their records to themselves. Forcing them to choose between the loans and their shoddy bookkeeping is a nice legal lever. Initially, I’d bet that they’d come to an agreement to rework a certain amount of these loans, in exchange for no discovery. On second thought, however, they’d be worried that if one city can get them to do this, there’d be a whole line of cities following in their wake.
Can you say “pick your poison”?
Do the banks really want outside lawyers documenting their atrocities when it comes to how they marketed their loan products in the minority community? Do they want their shoddy recordkeeping on public display? Do they want their delay-and-deny, “we lost your file” approach to various loan modification programs laid out for all the world to see?
Right now, the banks and Fannie/Freddie/FHFA are trying to get Richmond to back down. That’s their best hope. If Richmond holds firm (and MRP has pledged to pay all the legal bills), it’s going to be a terrible horrible really bad
day year for the banksters.
Which, as I noted several years ago, might make a number of local bankers and credit unions very, very happy. Big banks threatening to redline entire communities will not endear themselves to their current customer base, let alone new customers. Yes, the local banks and credit unions better get their advertisements ready, because things may get very ugly with the big banks very quickly.
photo h/t to Jeffrey Turner and used under Creative Commons Attribution 2.0 Generic license.