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If a California investment firm and the City of Richmond, California have their way, the mortgage industry may face a new threat: a plan to use government’s eminent domain power to seize homes where homeowners owe more than their homes are worth. San Francisco-based investment firm Mortgage Resolution Partners LLC (“MRP”) created its Homeownership Protection Program to do just that. Under the program, homeowners get immediate equity where they had none before, and MRP and the seizing city end up with a profit. The lender and anyone else with an interest in the mortgage loan lose.<br />  <br /> <strong>The Expansion of Eminent Domain</strong><br /> States and national governments traditionally have the power to exercise eminent domain to seize private property and use that property for a public purpose. This is how a row of abandoned houses becomes a new highway on-ramp or an old parking lot becomes a city park. Before taking the property, governments must pay the owner a percentage of the “fair market value.” The percentage varies by state, but many states require 75 to 80 percent of the fair market value to be paid. Although there may be a debate over the fair market value of a piece of private property, the significant point is that for so-called “underwater homeowners,” the fair market value of their homes is less than the mortgage they owe.<br />  <br /> In 2005, the Supreme Court of the United States took eminent domain a step further with its decision in <em>Kelo v. City of New London.</em> The Court’s decision in this case made it clear that a city could use eminent domain to seize private property that was not in a blighted area and transfer that property to a private developer. This was not to make a highway or a park, but to develop it in order to increase the city’s revenues.<br />  <br /> <strong>Eminent Domain for Profit</strong><br /> After the Supreme Court’s <em>Kelo</em> decision, it was only a matter of time until someone applied that rationale to home mortgages. Under the MRP’s Homeownership Protection Program, a city identifies homes worth less than the current balance of their mortgages. The city seizes those homes (with the consent of the homeowners), paying a percentage of the fair market value of the home. When the city pays for the property based on its fair market value (and not on the balance of the mortgage), the lender is receiving less than it contracted with the borrower to receive. Add to that the privilege the government has <em>of only paying a percentage of the fair market value</em> to get the property. That further decreases the amount the lender receives.<br />  <br /> Once the city owns the home, and the mortgage is gone, it can then sell the home back to the original homeowner for an amount more than the government paid for the home, but less than the fair market value of the home. The city makes a profit instantly. The homeowner goes from being underwater to having equity instantly. The lender loses.<br />  <br /> An example helps explain how MRP’s program works. Suppose a homeowner owes $250,000 on her mortgage, but her home is only worth $200,000. She is underwater. The borrower obtained her mortgage loan many years ago because a lender was willing to take a chance on her. That loan made it possible for her to buy a home because, practically speaking, few Americans have enough savings to pay cash for a home. Now, many years later, the city can seize her home through eminent domain. If it does so, it pays a percentage of the home’s fair market value of $200,000. Presuming the city pays 80 percent of the fair market value, the city gets to seize the home and extinguish the $250,000 mortgage for $160,000. The lender loses $90,000. Under the program, MRP provides the financing for the city. The city sells the home back to the homeowner for $180,000. The homeowner instantly has $20,000 in equity where she had none before (the difference between the fair market value of $200,000 and the $180,000 new loan). The city instantly makes $20,000 (the difference between the $180,000 it sold the home for and the $160,000 it paid for the home). MRP gets a cut of the government’s profit.<br />  <br /> MRP claims its program helps cities deal with the deepening crisis of underwater homeowners and provides an alternative to those homeowners throwing up their hands and abandoning their homes. Critics charge that the program will lead to increased interest rates and costs for borrowers to get mortgages.<br />  <br /> <strong>Richmond, California</strong><br /> MRP’s program is not just theory. For months, it shopped its program around the country, from Irvington, New Jersey to Oakland, California. Several cities and counties expressed interest, but none went as far as trying to implement the program. That was until MRP teamed up with Richmond, California. Its mayor decided the program made sense. The mayor and MRP identified more than 400 homes as candidates for the program, and the mayor contacted the lenders of the mortgage loans on those homes. She suggested the lenders refinance each of the mortgages. If they would not, she told them the city was prepared to use eminent domain to seize the homes and pay the lenders only a portion of the fair market values.<br /> <br /> In response, the trustees of hundreds of trusts that hold mortgage loans on homes in Richmond filed a lawsuit in federal court, seeking to stop the city before the plan went into motion. They claimed, among other things, the program was an unconstitutional taking of their property without just compensation. Richmond and MRP fought back, asking the judge to dismiss the lawsuit. They claimed it was premature since no action yet had been taken to seize a home. In the end, the judge agreed the lawsuit was premature and dismissed it, leaving Richmond and MRP free to proceed. The trustees appealed the decision, but a few weeks ago they dropped the appeal.<br />  <br /> The dropping of the appeal means the case is over. It leaves open the door for Richmond and MRP to start seizing homes. If they do, the trustees have vowed to immediately refile the lawsuit. We should see in the coming months whether the program ends up being an idea that never picks up steam or whether it represents a new challenge for an already beleaguered mortgage industry. Spilman attorneys will be monitoring the situation, so be sure to check back regularly for updates.<br /> <br /> <br />  

 

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