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The Ayatollah Buggeri

California Town To Compulsorily Purchase Houses In Negative Equity

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Wall Street Journal:

Banks representing some of the nation's largest bond investors filed suit against the city of Richmond, Calif., on Wednesday to block plans by city officials to seize and buy mortgages using their powers of eminent domain. The lawsuit, filed in federal court in San Francisco, could serve as a key test for whether a city can move forward with such a strategy, which would allow it to forcibly buy mortgages from investors at a price potentially below the property's current market value. The city would then reduce the loan balance and refinance the mortgage, resulting in a lower mortgage payment for the borrower. The aim is to help struggling homeowners avoid foreclosure.

The legal challenge could serve as a key test for whether cities from Newark, N.J., to Seattle are able to follow Richmond's lead.

The lawsuit was filed by three mortgage-bond trustees, units of Wells Fargo & Co. and Deutsche Bank, DBK.XE +1.18% that were directed to act by a group of investors, including BlackRock Inc., BLK +0.02% Pacific Investment Management Co., as well as Fannie Mae FNMA +3.03% and Freddie Mac, FMCC +1.60% the government-supported mortgage companies.

City leaders in Richmond, a working-class suburb of around 100,000 on the San Francisco Bay, began sending letters last week to mortgage companies seeking to purchase loans on 624 properties and threatening to force sales via eminent domain if investors resisted. The city is teaming up with Mortgage Resolution Partners, a private investment firm based in San Francisco, which was also named a defendant in the lawsuit.

At least four other California cities have signed agreements to work with Mortgage Resolution Partners, but none have taken the step of contacting bondholders about loan sales.

The lawsuit alleges that the proposed use of eminent domain is unconstitutional because it benefits a small group of Richmond citizens at the expense of out-of-state investors, violating the law on interstate commerce. The lawsuit also argues that loans aren't being seized for a valid public purpose—a key criterion for a city that invokes eminent domain.

<a name="U1009829063WMC">"Mortgage Resolution Partners has led the city of Richmond into an unprecedented use of eminent domain seizure that is unconstitutional, harmful to homeowners and taxpayers, and unfair to millions of individual savers and investors," said John Ertman, a partner at Ropes & Gray in New York.

An MRP representative said it was confident its proposal is "entirely within the law." "No investor in any trust will be made worse off by the sale of any loan," said a company spokesman.

Richmond officials said Wednesday they didn't have an immediate response to the lawsuit.

Eminent domain allows a government to acquire property by force that is then reused in a way considered good for the public—new housing or roads. Property owners are entitled to compensation, often determined by a court. Instead of acquiring houses, Richmond would buy the mortgages.

Legal advocates of the eminent-domain plan have said that constitutional challenges aren't likely to hold up in court. The loan strategy wouldn't burden interstate commerce "because it doesn't prevent credit from flowing in any particular way," said Robert Hockett, a Cornell University law professor who advocates for using eminent domain to seize underwater mortgages.

"This is a bluff," said Mr. Hockett. "It's meant to scare city officials into saying, 'Oh, who are we to argue with the big guns.' "

Supporters say their plan would help not only specific homeowners but also the broader community by reducing foreclosures that are hurting property values and eroding the tax base. "It's the responsibility of banks to fix this, and they haven't, so we're taking it into our hands," Richmond Mayor Gayle McLaughlin said in a call with reporters last week.

Of the loans that Richmond wants to buy, more than two-thirds, or 444, are current on their payments. Investors say that seizing loans that are current on their payments from mortgage-bond trusts would significantly degrade the value of those investments. They say if the plan moves ahead lenders will require significant down payments or higher rates in communities where the threat of loan-seizures exists—much the way a sovereign-debt default can raise borrowing costs for a country.

Ms. McLaughlin said threats by banks to raise the costs or change the terms of mortgages to borrowers in her city would amount to "redlining"—a term used for an allegation that banks have at times refused to lend money to certain communities where minorities live.

"It's not redlining," said Scott Simon, who retired in May as a managing director at Pimco. "If you were a lender, would you lend in an area that could literally say, 'Oh, I know you lent someone $100, but we are going to say you only get $50'?"

Investors also say they're worried that the seizures only make economic sense for a city if local officials are able to buy loans at big discounts. "You cannot invest where your money is going to be expropriated—that's a key tenet of investing," said Jonathan Lieberman, head of residential mortgage investing at Angelo Gordon & Co., an investment adviser. The firm is considering whether to join the lawsuit.

The Richmond plan would work like this: for a home with an existing $300,000 mortgage that now has a market value of $150,000, Richmond might argue the loan is worth only $120,000. If a judge agreed, the city's private financiers would fund the seizure of the loan, paying the current loan investors that reduced amount.

Then, they could offer to help the homeowner refinance into a new $145,000, 30-year mortgage backed by a government agency. That would leave $25,000 in profit, minus the origination costs, to be divided between the city, Mortgage Resolution Partners and its investors.

The proposal was set back earlier this year when officials in San Bernardino, Calif., voted against taking up the proposal after several months of hearings. But labor unions and community activists have helped galvanize support in a handful of new cities.

Wow! No wonder the banks want to squash this idea. And I can't say that I'm normally on their side, but if this idea catches on, the moral hazard is enormous. Buy a house at a bubble-inflated price you can't afford, then, when you get into trouble with the mortgage, elect a council that offers to buy it under eminent domain (from what I can gather, American for compulsory purchase order) and sell it back to you at a lower price! I suppose the only up side is that it would be a very efficient way of triggering a full scale HPC: all it would take is, say, a couple of dozen properties in a given area to have their book value reduced by this method (i.e. the land registry suddenly to show up sales prices dropping by a significant percentage), and then anybody trying to sell one of the other ones would suddenly discover that it was worth a lot less than they thought, too.

Edited by The Ayatollah Buggeri

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and then anybody trying to sell one of the other ones would suddenly discover that it was worth a lot less than they thought, too.

No problem. They'd then be in negative equity, so they could have their property compulsorily purchased at above market value and then resold to them at "market" value.

The whole scheme is unstable due to positive feedback. Once you start it, more and more people become eligible and demanding of it, and it becomes more and more difficult to reverse it...until the taxpayer can no longer afford it, and then the whole thing implodes catastrophically.

I must admit, I struggle to understand the thought process that conceived this scheme; but then, I'm not a politician.

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No problem. They'd then be in negative equity, so they could have their property compulsorily purchased at above market value and then resold to them at "market" value.

The whole scheme is unstable due to positive feedback. Once you start it, more and more people become eligible and demanding of it, and it becomes more and more difficult to reverse it...until the taxpayer can no longer afford it, and then the whole thing implodes catastrophically.

I must admit, I struggle to understand the thought process that conceived this scheme; but then, I'm not a politician.

The property wouldn't be compulsorily purchased at above market value - the explanation in the story says

"for a home with an existing $300,000 mortgage that now has a market value of $150,000, Richmond might argue the loan is worth only $120,000. If a judge agreed, the city's private financiers would fund the seizure of the loan, paying the current loan investors that reduced amount.

Then, they could offer to help the homeowner refinance into a new $145,000, 30-year mortgage backed by a government agency. That would leave $25,000 in profit, minus the origination costs, to be divided between the city, Mortgage Resolution Partners and its investors."

The city would only pay the original lender $120,000 for the loan i.e. less even than the market value of the property, and far less than the original loan amount. It's the original lender who might potentially lose out, having lent $300,000 and had, in all likelihood, less than $180,000 back in repayments. Hence the law suit.

If it worked, the city wouldn't lose money, it might even make money.

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I must admit, I struggle to understand the thought process that conceived this scheme; but then, I'm not a politician.

Or a Municipality afraid of outright default.When you look at it,they're going to go under either way,at least with this attempt to reverse the decline,in their eyes, they're taking a final roll of the dice.

Edited by Sancho Panza

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Wow! No wonder the banks want to squash this idea. And I can't say that I'm normally on their side, but if this idea catches on, the moral hazard is enormous. Buy a house at a bubble-inflated price you can't afford, then, when you get into trouble with the mortgage, elect a council that offers to buy it under eminent domain (from what I can gather, American for compulsory purchase order) and sell it back to you at a lower price!

You're absolutely right,this will be an absolute disaster for tax payers.

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Can't see a bank giving a mortgage in Richmond ever again if this happens.

If it's just Richmond that does this, then agreed. But if it catches on and becomes standard practice nationwide, i.e. city councils 'pressing the reset button' using this method if a bubble inflates and becomes dangerous, it will become just another risk that lenders have to factor in. If so, then they'll be reluctant to lend on a property anywhere if they feel that the price is unsustainably high compared to long-term sustainable norms. And that wouldn't be such a bad thing.

Edit: very significant that San Bernardino thought about this but decided against it. I live only 6-7 miles from SB - the place is in a very bad state. Just too far from LA and Orange County to be viably commutable; local economy hammered first by the closure of an air force base (like so many UK provincial cities, most of its economy was and still is public sector) that was the region's biggest local empoyer, and then by the bursting of the house price bubble in 2008. Unlike Britain, the Inland Empire had the HPC that in some ways it needed (the house my wife and I have just bought sold for $402k in December 2007, then $159k in January 2011, and we bought it for $166k last month). But the flip side of that is that property tax revenue fell through the floor, SB council went bankrupt in August 2012 and tens of thousands of the city's OOs are in NE and unable to get out. If SB had gone through with an eminent domain scheme, I'm sure the amount of money the original lenders stood to lose would have run into billions, possibly even tens of billions. Richmond is much smaller and the number of properties involved even smaller still, and so I'd speculate that they were trying to get this done under the radar. Whatever - it's going to be an important test case. If the councils in places like SB, Detroit, New Orleans etc. get the idea that it's viable and would work, that would be a game-changer.

Edited by The Ayatollah Buggeri

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I think this would be great news if it happened.

The Banks who were bust got bailed out by the state, same banks then screw some of the Cities and States, eg Detroit. If a City, Town Council or State then felt it might go bust, why not do this and drive the banks bust instead.

This might also be possible in the UK , if the right interpretation of of the compulsory purchase act can be used.

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It sounds like expropriation but without adequate compensation. It might be possible on a small scale, ut someone takes pain with a write down on. Perhaps even bank depositors. Or non home-owning savers pushed even further into the corner with opportunity to buy at better value.

Likely to make credit to states seize up further. Next they'll be calling to default on what they owe. Seize or default on the debt notes to creditors in the market, even take the banks over for themselves perhaps, and lend freely to themselves. Seize or default yourself rich at no expense.

The process of expropriation "occurs when a public agency (for example, the provincial government and its agencies, regional districts, municipalities, school boards and utilities) takes private property for a purpose deemed to be in the public interest, even though the owner of the property may not be willing to sell it." In regards to compensation, the owner should be in the same economic position as before the expropriation.

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Have a look at this from Ireland - hat tip shotoflight:

Mark Keenan – 17 August 2013

HUNDREDS of mortgage-holders are being told they need only pay half of their original borrowings as the market for home loans effectively becomes a lottery

Some fortunate mortgage-holders are now being offered 50pc writedowns by foreign financial companies which recently bought bad loan books from Irish lenders.Most of the deals are being offered to investors who owe money for more than one property.

The news that foreign-owned mortgage providers are offering massive write-downs to investors with several houses is sure to infuriate hard-pressed homeowners struggling to repay mortgages to the state-controlled banks here.

While some Irish banks have written down a few mortgages, the reductions are nowhere near as generous as those being offered to investors.

http://www.independe...s-29505899.html

Ireland has a state-sponsored NAMA bad bank in operation. My guess is that the written-down debt is ex-NAMA, ie. stuff that banks outside the jurisdiction were able to off-load onto the market for their own domestic tax purposes.

So the California eminent domain abuse is really pointing out that the state is NAMA anyway, and it might as well use its power to relieve its contributors (taxpayers who are mortgag debtors) in the short run. And in the long run? Pffff.

State subsidised lending on residential property - at whichever end of the sausage - is a mess, no matter how you look at it. In fact, it looks like the same pretence we have in the UK over selling public services to private sector monopolists.

Edited by okaycuckoo

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Here's an analysis on this scheme by a law professor, who sheds a little light on how it actually works and cui bono.

My link

In seeking to wrest control of these mortgages, Richmond can resort either to voluntary or coercive tactics. No one objects to the former. If the two sides can agree on a sales price, let them do it, as both sides will be better off. But now that the lenders have flatly said no, how can the city show that its offer is fair? Indeed, the gist of the bank’s complaint is that the city can make money out of this costly transaction by taking the RMBS trusts to the cleaners. The ominous financial implications of the proposed strategy are explained in stark terms in the complaint:

In an example provided by MRP, an underwater loan on a home worth $200,000 would be seized by eminent domain for $160,000 (or 80% of the home’s value), and then refinanced into a new FHA loan for $190,000 (or 95% of the home’s value). The $30,000 spread between the seizure price and the refinancing price would be divided (after expenses) among Richmond, MRP, and MRP’s investors.

So the town councillors and MRP (a bunch of bankers and financiers who are in cahoots with town councillors) get free cash, by forcing banks to surrender mortgages at below market value.

According to this law professor, this is going to be a big sticking point, as a key tenet of compulsory purchase is that the state offers "fair market value". This is controversion when it's slices of land, etc. but performing mortgages and RMBSs are liquid, market-traded instruments with clearly defined market prices and reasonable models of value for individual mortgages. It is unlikely that forcing the banks to accept a "derisory" price for the mortgages, would be legal.

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Whatever - it's going to be an important test case. If the councils in places like SB, Detroit, New Orleans etc. get the idea that it's viable and would work, that would be a game-changer.

How could it possibly work?

Local cities claim eminent domain,banks stop lending, house prices crash,tax revenues crash,Muni crashes.

Local cities lose,banks repo underwater properties-post taper,banks stop lending,house prices crash,tax revenues crash,Muni crashes.

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How could it possibly work?

Local cities claim eminent domain,banks stop lending, house prices crash,tax revenues crash,Muni crashes.

Local cities lose,banks repo underwater properties-post taper,banks stop lending,house prices crash,tax revenues crash,Muni crashes.

Not at all.

The banks will be able to lend much much more....lower amounts to far more people with much higher repayment capability and more money to spend in the community.

This seems to me a great solution, applying as it reads to those innovative eq ... It's aim appears to be placing the responsibility on housevaluation firmly in the banks... They stray from a democratic consensus of sensible they get burned. This looks as close to a solution to please thecrowd on here as is possible - and portable.

Hope they can make it work.

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So at the national level the Govt bailed the banks out, but now at the local level the authorities want to steal it all back and more.

Although I approve of the likely result on the housing market, I can't approve of local govt stealing in this way.

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This is doomed to failure those in power cannot let it happen.

Maybe it should happen, we have bailed out the banks with QE. What may have been a better approach is to use the QE to reduce debt levels of those indebted to the bank, with controls to stop them borrowing lots again.

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So at the national level the Govt bailed the banks out, but now at the local level the authorities want to steal it all back and more.

Although I approve of the likely result on the housing market, I can't approve of local govt stealing in this way.

Given the average dumb-ass house buyer cant say no at the best of times, lest they 'miss the boat', the likely effect will probably be that HPI goes into overdrive, as buyers know they cant pay too much because the state will always bail them out.

If I knew the state would bail me out, Id offer £20million on that £150k semi next door. What do I care? I'll take out the mortgage, default, keep the house and get a new mortgage for a 20th of the original one.

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To say this idea represents the creation of moral hazard is not correct- what it represents is the opposite- it corrects the moral hazard that has been created by the bailout of reckless speculators.

If this goes through what are the chances of the bankers engaging in reckless mortgage lending in the future? I would say very low- after all if they believe that they will ultimately pay the price then for them it's a very dangerous game to play.

Sure- in theory- future borrowers could take on massive mortgages in the belief that they would be bailed out- but in practice no banker is going to be dumb enough to lend them that kind of money ever again.

This should happen- it will kill the idea of speculating in the property market for a long time to come.

It's interesting to note how in the last analysis the crooks on wall street depend on the enforcement of the rule of law to protect their ill gotten gains- should the rules be altered via measures of this kind they will be front and center wailing about the sanctity of the law and the vital need for it to be maintained. :lol:

For fans of Irony that would be a sight to see.

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To say this idea represents the creation of moral hazard is not correct- what it represents is the opposite- it corrects the moral hazard that has been created by the bailout of reckless speculators.

If this goes through what are the chances of the bankers engaging in reckless mortgage lending in the future? I would say very low- after all if they believe that they will ultimately pay the price then for them it's a very dangerous game to play.

Sure- in theory- future borrowers could take on massive mortgages in the belief that they would be bailed out- but in practice no banker is going to be dumb enough to lend them that kind of money ever again.

This should happen- it will kill the idea of speculating in the property market for a long time to come.

It's interesting to note how in the last analysis the crooks on wall street depend on the enforcement of the rule of law to protect their ill gotten gains- should the rules be altered via measures of this kind they will be front and center wailing about the sanctity of the law and the vital need for it to be maintained. :lol:

For fans of Irony that would be a sight to see.

That's how I see it - lending would shrink massively as banks could not be sure of getting their overblown loans back. Next best thing to a legally set income multiple/LTV limit.

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