After quite a bit of searching, Mortgage Resolution Partners (MRP) has finally found a town willing to take a chance on its plan to use eminent domain to help underwater homeowners. The details for this specific plan aren’t quite clear yet, but this plan still has a major problem. Let’s first look at how this will work.
Richmond is giving investors a choice: either willingly sell or we’ll use eminent domain to force you to sell. According to the New York Times, the city is offering to pay what it deems to be fair market value:
The city is offering to buy the loans at what it considers the fair market value. In a hypothetical example, a home mortgaged for $400,000 is now worth $200,000. The city plans to buy the loan for $160,000, or about 80 percent of the value of the home, a discount that factors in the risk of default.
MRP’s plan has been to put up the capital for these purchases so that no taxpayer money is involved. After it has purchased the loan – either by agreement or by force – the city will write down the value of the loan so that the homeowner is no longer underwater and can refinance at lower rates:
Then, the city would write down the debt to $190,000 and allow the homeowner to refinance at the new amount, probably through a government program. The $30,000 difference goes to the city, the investors who put up the money to buy the loan, closing costs and M.R.P. The homeowner would go from owing twice what the home is worth to having $10,000 in equity.
Done correctly, using eminent domain to purchase underwater homes is a promising idea. Unfortunately, MRP’s plan has always been aimed at helping investors make a nice profit, not helping out homeowners. This plan has the same major flaw: it doesn’t just write down loans for homeowners delinquent on their loans, but also for borrowers current on them.
The intellectual godfather of the plan, Cornell professor Robert Hockett, noted in his paper promoting the plan that MRP would only contribute capital to use eminent domain for mortgages that are current. The problem with this is that these are the homeowners who don’t need help. Yes, they are severely underwater and would be helped by a principal write down, but they aren’t defaulting on their loans. They are still able to make their payments.
Of course, for that reason, those borrowers are also the most valuable for investors. Homeowners current on mortgage payments on a $400,000 loan that is for a house worth only $200,000 is still profitable. The security is no longer worth face value since the losses in the case of default are now higher due to the lower home value. But that means the loan is worth somewhere between $200,000 and $400,000, depending on the risk of default. Since the home is worth $200,000 now, the loan is worth more than 100% fair value of the home.
MRP’s original plan was to only use eminent domain for homeowners current on their mortgages and would not pay anything more than 85% the fair market value of the home. As just shown, these loans are worth more than 100% the value of the home. No investor would ever be willing to sell at this price, even if it could solve the collective action problem that permeates the housing market (more on this later today).
However, this is the only way MRP makes money. If it were to purchase the loan for $250,000 (as it may be worth) and then refinance it at $200,000, it would lose money on the transaction. The only reason that the company earns a profit is because it’s using eminent domain to pay significantly less than the fair value of the loan.
Banks are (rightfully) furious at Richmond’s plan and will undoubtedly take this to court, arguing that the proposal is unconstitutional in a number of ways. Not least of all is the fact that eminent domain requires the city to pay fair market value for property. In purchasing the mortgages of homeowners who are current on their loans, Richmond is certainly not adhering to that rule. What really sucks for the city is that banks will likely freeze credit in the area as both a punishment and a deterrent to warn other cities not to follow in Richmond’s footsteps. Maybe more details will emerge that make this plan look like a better deal, but right now it’s looking like MRP finally duped a municipality into implementing its plan and Richmond is going to face severe consequences for doing so.