Sunday, September 22, 2013

Mortgages, Eminent domain and Richmond

by Bill McBride on 9/22/2013 10:21:00 AM

I was hoping to avoid writing about this dumb idea, but readers keep asking ...

Mike Konczal writes in the WaPo: Is Richmond’s mortgage seizure scheme even legal?

The short answer is No (Although Konczal apparently disagrees).

There are some confusing passages in Konczal's piece. The key issue is if there is a public interest for the city of Richmond to use eminent domain. Konczal writes:

It is very likely Richmond will argue that preventing blight is a major, legitimate public purpose, and the courts agree. Abandoned homes result in increased crime and significant public costs, in addition to destabilizing neighborhoods. ... The banks argue that the loans are performing (more on their argument about this in a minute), and as such don’t serve a public purpose. But there’s also a public purpose in solving problems in the coordination of mortgage servicers to writedown and deal with failing mortgages. There’s also the public purpose of allowing people to move as well as refinance allowing for the movement of individuals as well as the ability to refinance. These are all legitimate purposes of eminent domain ...
First, blight is a legitimate issue for eminent domain, but blight doesn't apply in the Richmond case. Most of these homes are owner occupied and the owners are current on their mortgages. The "abandoned homes" is mostly irrelevant in this case (there might be a few abandoned). Drive down any street in Richmond with one of the houses in question, and there is no evidence of "blight". Note: For any house that is not maintained, the city has alternatives to eminent domain - so we can rule this one out.

Konczal also writes "there’s also a public purpose in solving problems in the coordination of mortgage servicers to writedown and deal with failing mortgages". But once again, most of these loans are current and the mortgages are not "failing".  (I don't buy the public interest argument for a city with coordination).

Konczal also writes: "There’s also the public purpose of allowing people to move as well as refinance allowing for the movement of individuals as well as the ability to refinance." A public purpose in "allowing people to move"?  Clearly Konczal is suggesting that someone underwater on their mortgage will have difficulty moving for employment. That may be true - they may have to lose their home in foreclosure or do a short sale to move from say Richmond to Texas - but helping someone move might be in the national public interest, but not in the interest of the city of Richmond. And a public purpose to "refinance"?  That is a stretch.

Also even if there is a little public interest, most of the benefits accrue to individual homeowners - and that violates the spirit of eminent domain.

I think there is no clearly stated public purpose for using eminent domain. And this is how I expect the courts to rule.

Konczal writes about valuation.
One way to evaluate these mortgages would be to compare them to bonds of mortgages containing similar instruments and see what discount is used. Given the still high levels of foreclosures, this would generate a significant discount. This is a common technique to evaluate risk and valuations when markets aren’t available, say for understanding the credit risk of a brand new company, as they aren’t in high foreclosure areas.

The banks also argue that the fact that a majority of homeowners are current on their loans means that they aren’t relevant to either public purpose or subject to a steep discount.
I won't discuss the difference between the mortgage and the promissory note, but the first key here is that the valuation is for the note, not the underlying property.

Pop quiz: Say someone with excellent credit buys a new car for $30,000 with 100% financing. They drive the car home, and the car is now "used" and only worth $25,000 (I'm making up numbers for this example). What is the value of the note (the loan)? Of course the value is $30,000 even though the car is now only worth $25,000.

The same idea applies to loans on houses. If the outstanding principal balance is $400,000, but the house is only worth $250,000, the starting point for the value of the note is $400,000. As Konczal writes the value could be discounted because of the possibility of foreclosure, but these loans are current and well seasoned (the borrowers have been paying for eight years or so). The value might be less than $400,000, but the value is clearly more than $250,000 - so the scheme doesn't work since the intention is to "seize the mortgage" and refinance at less than the current property value - but that will be far below fair value for the note.

The bottom line is I expect the courts to rule against this scheme (little or no public interest) - and it wouldn't work anyway (can't pay fair value).

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