Two major banks sued the city of Richmond and a San Francisco investment firm Wednesday over a plan to use the city's power of eminent domain to seize underwater mortgages and slash the amounts that borrowers owe.
In a complaint filed in federal court in San Francisco, Wells Fargo and Deutsche Bank said the plan was an illegal scheme to let the firm, Mortgage Resolution Partners, and its investors reap windfall returns "with Richmond receiving a small cut of the profits as its fee for renting out its eminent domain powers."
They asked the court to stop it before any mortgages were seized by the city.
Steven Gluckstern, chairman of Mortgage Resolution Partners, said in a statement that he was confident the lawsuit was "without merit" and that the plan was legal.
"Sadly," he said, "the financial institutions that brought us this crisis are yet again part of the problem rather than part of the solution."
The mortgage industry has threatened legal action against any city that implemented the idea since the firm started shopping it around last year to cities including Sacramento, San Bernardino and Chicago. None proceeded with the plan.
Richmond, a working-class city in the San Francisco Bay Area with a large number of residents who owe more than their homes are worth, is the first city to begin implementing it. Last month, the city sent out letters to trusts that hold the mortgages, offering to buy hundreds of loans, the lawsuit says. The banks act as trustees for those entities.
The next step could be to use eminent domain to take the loans. Such a move would be unconstitutional and could undermine the nation's mortgage industry, the complaint claims.
In contrast, MRP claims its plan would help thousands of struggling homeowners who owe far more than their houses are worth. A positive outcome for any city would set off a chain reaction of communities eager to embrace MRP's proposal, Gluckstern said in an earlier interview.
"If it happens and happens successfully, it will spread like a wildfire," Gluckstern said. "That's one of the reasons the opposition is working so hard to prevent us from being successful."
Under its proposal, Mortgage Resolution Partners says it will help cities identify mortgages to purchase or take through eminent domain, which is normally used to seize property for public projects such as highways.
Only mortgages bundled into so-called private label securities would qualify; those backed by federal mortgage giants Freddie Mac and Fannie Mae would not be included.
The firm recommends buying only mortgages on which homeowners are current on payments causing opponents to level charges of cherry-picking performing loans while leaving troubled loans untouched.
MRP's investors would front the vast sums to local governments to buy the mortgages. The purchase price must be less than a home is currently worth. MRP claims this discounted price would in fact be fair market value once the costs to the lender of going through the foreclosure process are considered. Opponents argue it's a rip-off that shortchanges note holders.
With MRP's help, the homeowner would then refinance at the home's current value. Investors, local governments and MRP would split the difference. Gluckstern uses this example: A homeowner paid $300,000 for a home in the boom that is now worth $200,000 and has a mortgage for more than that. A city would seize the mortgage and pay the note holder $160,000. The homeowner would refinance for $190,000, with MRP, its investors and cities sharing the profits.
Call The Bee's Hudson Sangree, (916) 321-1191.