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Pirates of the Eminent Domain

August 14, 2012

A couple months ago I remember seeing a blog on a concept that I did not give much credence to because it seemed too extreme. The blog reported that there was an idea being proposed for the government to use eminent domain* to purchase homes that were ‘underwater’ — these are homes in which more is owed on a house than it was worth, and the mortgage is greater than the home’s value. In many cities in California, ‘underwater’ would describe the majority of mortgages. Anyway, when I first read the blog reporting on this idea, I didn’t look at it too closely because I thought for sure that it would not go anywhere as it would certainly be deemed illegal. After all, why waste my limited time and brain cells on analyzing a story that reported on some crazy idea that won’t see the light of day.

As I unfolded my newspaper Saturday morning, I was stunned to read the following headline: Sacramento area officials explore using eminent domain to aid underwater homeowners.” The article went on to explain how various cities in Sacramento County were considering seizing underwater mortgages, utilizing their powers of eminent domain.

There is a lot of blood in the water from home owners burned by the housing bubble and ’predatory’ lending practices. And we all know that blood in the water will often attract a lot of sharks… this is no exception. Mortgage Resolution Partners (MRP), apparently one of the brain children of this proposal, described how the program works. First, they encourage the city to ‘target only underwater mortgages on which borrowers are current on their payments.’ Let me explain it another way; they will target the most profitable and least likely to default mortgages. These are not the boarded up or ransacked eyesores that devalue neighborhoods. These loans are the few money makers, or performing loans in a securitized pool.

The article quotes Timothy Cameron, an executive with the Securities Industry and Financial Markets Association, who called MRP’s plan a strategy for “short-term opportunistic investors to make a 20 to 30 percent profit” by “cherry pick(ing) the best loans out of a securitized pool and buying at a substantial discount.”

The article goes on to explain how the program would work and also reveals who profits from this abuse of property seizure under the eminent domain laws. Steven Gluckstern MRP Chairman gave this example: A homeowner paid $300,000 for a house during the boom. That house is now worth $200,000, with a mortgage balance much higher than that. A city would seize the mortgage and pay the note holder $160,000. Gluckstern contends that would be fair-market value, after the potential costs of foreclosing on the mortgage are deducted.

The idea is not for the city to become a lender. Instead, he said, the homeowner would refinance his mortgage at $190,000, with help from Mortgage Resolution Partners. The extra $30,000 would be split between investors, local government and MRP, which would make a flat fee of $4,500 per transaction.

Wow!!!

Let me get this straight: we are going to use eminent domain to seize non-delinquent mortgages; buy them at a steep discount from their already hugely depressed prices by assuming they will default; then split the profits between the company that created the concept, some private investors (I would like to see how one gets on that list) and the city that decides to use eminent domain in this way?!?!?!?? It should be noted that these are pretty much guaranteed profits… guaranteed because the local government is holding a gun at the homeowners’ and original mortgage holders’ heads. With concepts like this being seriously considered, is it any wonder why people begin to lose hope in their elected leaders?

One may ask who is this negatively affecting. Doesn’t the homeowner make out? Not everyone can be winners — there is always an entity that loses. It could be private investors or even a pension fund, for example. Let me do the reverse math. I invest for a pension system that had invested in traditionally safe investments of mortgage backed securities (MBSs). Many of these mortgages in my securitized pool are no longer performing; the homeowner has decided to not pay for their underwater mortgage. There are a few performing mortgages left in the pool; these are the very mortgages targeted by this eminent domain scheme. In my devalued securitized mortgage pool, the best/only performing loans will be skimmed off the top for seizure by the city, with profits split by the sharks. So one of my performing loans, let’s say it was a $500,000 mortgage based on the purchase of a home in Elk Grove, which was very typical in 2005/06. This home is now only worth $250,000, also very typical in this region. There have been no missed payments and no indication that the homeowner will default, but MRP identifies it as a targeted mortgage. In steps the city, with MRP and private investors’ assistance, declaring a seizure under eminent domain. The homeowner is told they will be given a new mortgage of $240,000; no complaints here so far. MRP determines fair market value of the home is $250,000, less their estimate of foreclosure costs of $50,000. Their very private investors provide the city with the $200,000 to purchase the home. MRP finds a new lender and informs the happy homeowner that their mortgage has been dropped by more than half of what they owed on their previous mortgage. MRP takes their $4,500 off the top leaving $35,500 to be split between the city coffers and the private investors; that is $17,750 for each. Not a bad return for a couple of months’ work, especially when you multiply this scenario by thousands of underwater performing mortgage loans within selected cities.

So who is the loser in this deal?

In my example it would the members of the pension fund who had their investments placed in the securitized mortgage pool that contained this specific mortgage. Remember, in this example I am the one investing your pension funds. When I originally bought a portion of these mortgage backed securities in 2005, I believed they were relatively safe investments, because they were backed by the value of the home—a homeowner defaults, I have the home as collateral. Since that time I have watched the value of our MBS portfolio decrease dramatically as homeowners have walked away from their underwater homes leaving the owners of their mortgage with greatly devalued real estate. Fortunately, there are some homeowners who have decided to continue to pay on their mortgage even though they are in a negative equity situation, helping this specific pool to not completely hemorrhage… that is until MRP with the city’s eminent domain powers interfered with the original loan. Now MRP, their private investors, the city and even the homeowner have all benefitted at the expense of the pension fund to the tune of $300,000 on just this one single loan owned by the fund through their MBS investments. Now multiply that by hundreds or thousands of other ‘cherry-picked’ mortgages seized under eminent domain and you are shifting huge sums of money away from those investing in original mortgage securities.

In our upside-down world of finance, this concept is so upside-down that it appears to some to be right-side-up. I honestly struggle to see how anyone could view this proposal as anything other than opportunistic and as an abuse of power.

*Eminent domain is an action of the state to seize a citizen’s private property, expropriate property, or seize a citizen’s rights in property with due monetary compensation, but without the owner’s consent.

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