Last night, Richmond, California’s city council approved the plan to use eminent domain to help underwater borrowers by a vote of 4-3. The plan is pure fraud. Mortgage Resolution Partners (MRP), an advisory firm, rounded up investors to supply capital to Richmond so that it could purchase the mortgages of underwater borrowers in the area. The city would then right down the value of the loan so that the borrowers could refinance at a lower rate. However, MRP wasn’t just helping out the city. It was looking to make a profit. And how was it doing that? By paying investors well below fair market value for the loans.
I’ve said repeatedly that I have no idea how Richmond fell for this plan. These two tweets from Wonkblog’s Lydia DePillis, who was at the meeting, may explain it a bit:
A dysfunctional city council that doesn’t understand what they’re voting on is about the best explanation I’ve heard for why the city is implementing MRP’s plan. Still, I was hoping someone would talk some sense into the council members and explain to them why this is such a bad idea. Unfortunately, that hasn’t happened.
Not much has happened in the past couple of weeks with Richmond, California’s use of eminent domain to help underwater borrowers. As I’ve said a couple of times, this is just a big scam by the firm supplying the capital, Mortgage Resolution Partners (MRP), and Richmond fell for it. It’s come out recently that the borrowers of the mortgages MRP is looking to seize are current on their payments. Banks and investors, not surprisingly, have no interest in giving these up and have filed a lawsuit to stop the plan. MRP pushed back with a ridiculous argument:
[MRP Chief Strategy Officer John] Vlahoplus, of Mortgage Resolution Partners, disputed the analysis, saying he’s confident that all of the 624 borrowers are indeed underwater. The city’s appraisals of the properties, he said, were handled by a firm whose work has been highly rated by securities trade groups.
About two-thirds of the borrowers have indeed stayed current on their loans, he said. But helping them now — before they default — is the best way to make sure they stay current on the loans and thereby limit further damage to Richmond’s battered neighborhoods.
“The intent here is to help the neighbors,” he said.
This is absurd. All of these mortgages were created before 2008, meaning that two-thirds of these borrowers have weathered the Great Recession and are still making on-time payments. These are performing loans. Investors love them. And now MRP is coming in and seizing them at well-below fair value to prevent them from defaulting in the future. After the economic disaster of the past six years, what are the odds that now these homeowners are going to default with the economy improving? Very low. And MRP is doing all of this is to help the neighbors!
Give me a break. The brashness of this argument is truly astounding. I have no idea how Richmond fell for it and I can’t imagine that any judge will as well. And it still overshadows the fact that eminent domain really could be a powerful tool to help underwater borrowers. What a shame.
It’s a slow news day so I’m going to return to my favorite pet subject: the use of eminent domain to help underwater homeowners. As regular readers know, I believe eminent domain could be used to help such borrowers, but the current plan being implemented in Richmond, California is outright fraud. Most analyses of it that I’ve seen have come to a similar conclusion, but University of Georgia Professor Stephen Mihm wrote a defense of the proposal last week. The piece is actually very good – particularly the history of the use of eminent domain to seize intangible assets (like mortgages). But Mihm misses the reason why Richmond’s plan is such a rip off. He writes:
Richmond’s plan is to seize 624 mortgages valued at more than the homes for which they were written. Relying on a private intermediary, the city would compensate the investor holding a mortgage at a price reflecting the home’s current value rather than an inflated bubble value.
This is the problem. Investors don’t own these homes – they own the mortgage-backed securities associated with him. Those MBS are not worth what the value of the home is. They are worth a certain amount depending on the future stream of payments from the mortgage, the initial par value of the loan, the current value of the home and the likelihood that the borrower defaults. In fact, the worst case scenario for investors is that the homeowner defaults immediately, they foreclose on the home and they only recoup the current value of the home. Thus, the minimum value of the MBS is the current home value. The actual value of the MBS is well above that. Yet, Mihm is arguing that paying those investors the current value of the home is fair value. It’s not at all.
Mihm concludes his piece by saying:
Yet to listen to the hysterical denunciations of the Richmond plan, a proposal to bring 624 mortgages in line with market prices is the epitome of eminent domain abuse. History suggests otherwise.
It may not be the greatest abuse of eminent domain, but it certainly is abuse. The private firm supplying the capital to purchase the securities – Mortgage Resolution Partners (MRP) – makes a tidy profit by buying the securities as well-below fair value. That’s the definition of abuse.
What makes this even worse is that eminent domain could be used to help those borrowers. Richmond would have to pay investors fair value for their investments – and they probably would still file lawsuits against the town – but the plan could work. Unfortunately, using eminent domain in this fraudulent manner prevents it from ever taking off in a legitimate one.