City in a David vs Goliath battle to cut mortgage debt

RICHMOND is a heavily working class, Latino and African-American community of 106,000 across the bay from San Francisco, north of Berkeley. During the Second World War, its shipyards set records for the speed with which they turned out the Liberty supply ships that made Allied victory possible.

Today, the city is in the news for the potentially precedent-setting tactics it has adopted to reduce the mortgage debt of homeowners who bought at the top of the market on the theory it would go up forever and now owe considerably more than their properties are worth.

The median Richmond house price having fallen from $450,000 in 2006 to $220,000, just more than half of all mortgage bonds in the city are said to be underwater.

The city’s management, led by the only mayor in the country who is a member of the Green party, has said that if lenders are not willing to restructure mortgages to reflect current property values, Richmond will do the job for them through compulsory purchase of the bonds at “fair market prices”.

The city will, in effect, force creditors to sell troubled mortgages at a court-adjudicated discount to a purpose-built private company, Mortgage Resolution Partners, launched by former Rhodes scholar John Vlahoplus, who has been raising the capital to buy them.

Eminent domain, the American term of art for the compensated taking of private property by the state, is as expressly permitted under the US constitution as it is by SA’s.

The US Supreme Court long ago determined that almost any kind of property could be seized so long as a public purpose was served. The court has been generous too in its interpretation of public purpose. In 1984, the nine-member bench ruled 8-0 that Hawaii could use eminent domain to expand land ownership beyond a narrow elite in the name of fairness and social harmony.

More recently, the court said the city fathers of New Bedford, Connecticut, had every right to take land from one private owner and sell it to another set if the latter’s for-profit use of it would generate more jobs and tax revenues.

Richmond says its use of eminent domain will serve several public purposes. It would forestall the neighbourhood blight and attendant loss of property values and taxes which result when homeowners abandon properties they can no longer afford or are foreclosed upon.

The local economy would gain from improved disposable incomes and increased home sales. Investors — mostly hedge funds and institutions — in whose portfolios the debt now sits would stand to benefit.

None of the mortgages in question — there are 642 — is owned by a single lender. No sooner were the loans originated than they were sold on, carved up and repackaged. This was the notorious financial alchemy by which loans extended to uncreditworthy borrowers by predatory lenders were converted into AAArated securities, helping to pump up the bubble that popped in 2008.

With scores of different investors owning slices of each underwater mortgage, there is what housing economist Robert Shiller calls a collective action problem.

Home loans held in mortgagebacked securities (MBS) are more likely to default than those held by traditional lenders. But when each individual mortgage has so many different owners, the difficulty is getting their assent to restructure.

The middlemen collecting fees for seeing mortgage payments flow to MBS-owners have little incentive to help. By forcing everyone’s hand, eminent domain may solve this.

Wells Fargo and Deutsche Bank take a different view. They have sued, so far unsuccessfully, to stop Richmond before it even starts. For them, using eminent domain to enforce debt forgiveness is understandably alarming. It could metastasize across the country — and loan classes.

The Obama administration, whom critics accuse of having bailed out Wall Street at the expense of Main Street, is no fan of Richmond’s approach, despite initial enthusiasm when the founders of Mortgage Resolution Partners canvassed candidate Barack Obama in 2008.

Local real estate agents don’t buy it either. They see lenders making it more difficult to get a mortgage in Richmond, depressing property prices and ruining their business.

The city tried to raise $34m on the municipal bond market. In what many see as a co-ordinated investment strike, there were no takers.

Then there are those like Reason, the libertarian magazine, who view Richmond’s use of eminent domain as crony capitalism — politicians using the power of the state to transfer stolen assets to their friends.