Sacramento and Elk Grove officials are exploring a controversial plan to use their powers of eminent domain to seize underwater mortgages from private investors and slash the amounts borrowers owe.
The proposal, pushed by a San Francisco-based group of financiers called Mortgage Resolution Partners, is meant to alleviate the drag on local economies of thousands of homes worth far less than buyers paid. It's also meant to turn a handsome profit for investors who would advance the vast sums needed to buy the mortgages.
The proposal has infuriated opponents in the mortgage industry. They call it an illegal use of eminent domain, a power that gives government the right to seize property for the public good while paying just compensation.
But leaders in the Sacramento region as well as in San Bernardino County, Chicago and other areas hammered by the housing crisis say years of depressed home prices have made them desperate for solutions they can implement at the local level. Help from lenders and from the federal and state governments has been slow to arrive and insufficient, they say.
Sacramento City Councilwoman Angelique Ashby is among the local officials talking to Mortgage Resolution Partners. Ashby represents the subdivisions of North Natomas, a suburban expanse north of downtown that was erected during the boom. She said many of her neighbors are clinging to their houses despite being underwater.
"The bottom line here is that Natomas is one of the worst-hit communities in the country," Ashby said. "If there's a plan or proposal that would help my constituents, I definitely want to hear about it."
The idea first gained traction in Southern California, where officials in San Bernardino County and the cities of Fontana and Ontario recently formed a joint powers authority to examine the eminent domain plan. The JPA's next hearing is Thursday.
San Bernardino County Chief Executive Officer Greg Devereaux said he's interested in an idea that could revive home building, once an economic powerhouse in the county, and prevent foreclosures. About half of all homeowners in San Bernardino are underwater, about the same percentage as in Sacramento.
"It would be irresponsible not to at least look at the idea and publicly vet it to determine if it has merit," he said.
Ashby said she hopes to convene a meeting of leaders from cities such as Elk Grove and Roseville, which experienced fast growth in the housing boom and steep price drops afterward. "I want to bring in everybody in the region that's interested in learning more, and we can decide together," she said.
Gary Davis, an Elk Grove city councilman, said he, too, has spoken with Mortgage Resolution Partners. "I'm intrigued by the notion," Davis said. We're engaged in a conversation with the group to better understand it."
Mortgage Resolution Partners' Chairman Steven Gluckstern explained the complex plan to The Bee. While eminent domain is most often used to wrest real estate from private owners for public projects such as roadways, Gluckstern maintains it can also be used to seize intangible assets such as stocks or mortgage notes.
His firm recommends that cities and counties target only underwater mortgages on which borrowers are current on their payments. Those loans have the best chance of being refinanced and of contributing to the success of the program, Gluckstern said.
"People who are in default, we would like to be able to help them, but it's more complicated," he said.
Loans backed by Fannie Mae and Freddie Mac would not be included. It would be difficult, if not impossible, for local governments to seize assets associated with the federally sponsored mortgage giants, Gluckstern said.
Private investors would front the money to local governments to buy the mortgages from note holders. In return, they would earn a profit margin of about 7 percent or 8 percent on each transaction which could potentially produce a return of 20 percent or more annually, Gluckstern said. The profit would come from the difference between what local governments would pay for the mortgages and the amount homeowners would pay to refinance.
Gluckstern 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.
In the end, the homeowner would end up with a lower mortgage payment and a different loan servicer. "The objective is to keep you in your house," Gluckstern said.
Critics in the mortgage industry say the real motive is money.
Timothy Cameron, an executive with the Securities Industry and Financial Markets Association, 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."
SIFMA has argued through its lawyers that using eminent domain to seize mortgages would amount to an unlawful taking. In a legal memorandum, former acting U.S. Solicitor General Walter Dellinger, now an attorney with O'Melveny & Myers in Washington, D.C., argued that note holders could contend the mortgages aren't being taken for a legitimate public use.
He also questioned whether buying the loans for less than the homes' current value would constitute the "just compensation" required by eminent domain. He said it's inaccurate to assume that all underwater borrowers will eventually default, an assumption needed to justify paying less.
"In fact, loans still performing after many months generally do not default," he wrote.
Cornell University Law Professor Robert Hockett, a legal adviser to Mortgage Resolution Partners and a designer of the plan, called those arguments baseless.
The plan's aim to uplift underwater housing markets is well within the broad legal definition of a public purpose, he said. And it will be up to the courts to determine fair market value.
SIFMA hired prominent law firms "to put together silly frivolous analyses (to) scare away cities that might be contemplating this," Hockett said. "It's an intimidation tactic that's not particularly subtle or clever."