City seizes underwater mortgages to help struggling borrowers
Very early on a Wednesday morning in September, the city council of Richmond, Calif., did something that no American city had yet managed: It voted for a plan to wrest underwater mortgages from the hands of Wall Street, depriving investors of tens of millions of dollars in order to save borrowers from foreclosure.
For communities across the land -- North Las Vegas, San Bernardino County, Calif., Chicago -- where too many are stuck with house payments beyond what they can afford, this was the nuclear option. While those cities backed away, Richmond hit the button.
The mechanism? Eminent domain, the power of the government to seize private property for public use, which has not typically been used to help poor neighborhoods. After five years of the federal government gently nudging banks to forgive homeowners debt they took on in better days, cities have found a legal weapon the financial industry truly fears.
The stability of those housing markets, and the banks that profit from it, could depend on the fallout.
The strategy's complexity has left stakeholders to lean on dogfight rhetoric: From the community activists, "Save homes, stop foreclosures." And the Realtors, "Stop investor greed." And the lawyers for the investors, "Prevent this unconstitutional investment scheme."
In short, here's how it would work: Richmond condemns mortgages on homes that are now worth far less than what the borrower owes. The note holders -- investors such as pension funds and mutual funds -- are forced to settle for the current fair market value. The city pays for this with cash from a new set of investors, who now own the mortgage. The new price is set by the current market, and the borrower settles into a more manageable loan.
It's that smashing of the bond between lender and debtor that animates investors. They've acted aggressively to stop it, lobbying the mayor and council members directly. Wells Fargo and Deutsche Bank, on behalf of scores of investment funds, sued to stop the plan. The securities industry points out that the plan would also hurt pensioners who own pieces of Richmond's mortgages. Indeed, last week, California Public Employees' Retirement System -- the safety net for some Richmond workers -- joined the suit.
Richmond couldn't get insurance to shield it from a crushing judgment -- if it lost its bid to spare struggling homeowners, the city could find itself underwater.
In the backlash to the plan, the market boycotted the city's most recent bond issuance, forcing it to withdraw the $34 million offer, which was supposed to refinance earlier debt.
Richmond's leaders stared hard at the threats. In the end, it seemed to only harden their resolve.
"They sold everybody a dream, and said 'you have to own a home, or you're not American,' " said Council member Joel Myrick, explaining to an auditorium packed with yellow T-shirts (those for seizing the mortgages) and red (those against it) why he voted in favor of using eminent domain. "I am not willing to allow people to be dependent on the generosity of these same banks that are suing us in order to be able to pay off their loan before they die."
After the council vote, a district court judge threw out the investors' complaint as premature -- not on its merits, but because the city hadn't actually seized any mortgages yet.
"This is not a victory for the program and only postpones the day that Richmond and Mortgage Resolution Partners will have to defend this program in court," the banks' lawyers said in a statement.
A courtroom victory for Richmond, a town of about 100,000, could give cities around the country the courage to act -- and potentially help keep millions of people in their homes. But even a win could spell defeat for Richmond if the financial industry cuts off lending to make an example of the city.
So why hit that button? And what would it mean if other cities did the same?
The plan for using eminent domain to seize mortgages has at least three parents: Cornell Law professor Robert Hockett, Loyola University's Lauren Willis and Harvard's Howell Jackson, who independently came out with proposals as the housing market was starting to collapse.
"We all three came to the idea more or less at the same day back in September of 2008," said Hockett, who went on to become the strategy's chief academic exponent. "It became clear that housing prices were going to drop in a profound way, and that there were going to be a lot of foreclosures."
They noticed two things:
_Although it was in the banks' interest to write down the principal on loans to avoid an outright default -- after all, it's better to get something than nothing -- the mortgages that had been reshuffled into pools of securities owned by many different investors were much more difficult to modify, because so many different investors would have to sign off on the change. Because of that, these "private label securitized" loans are more likely to default than the banks' portfolio loans.
_Governments could help unwind that tangle by using eminent domain to facilitate an exchange between a bunch of investors who were likely to lose most of their money to a few other investors who'd give them cash up front equal to the fair market value of the loan. In effect, it's breaking what Yale housing economist Robert Shiller calls real estate's collective action problem, wherein a large group of investors can't coordinate to act in their shared best interests.
At first, Hockett thought he might be able to get it done on the federal level, through the Troubled Assets Relief Program. He says he had strong interest from someone high up on Barack Obama's 2008 presidential campaign team, but it quickly waned. "It became clear they were going to bail out the banks directly, rather than help them indirectly, by helping the homeowners," Hockett said.
Then-Rep. Brad Miller, D-N.C., proposed his version, a throwback to a New Deal-era government agency that bought distressed mortgages from banks and relaxed requirements on their borrowers, taking the edge off a ballooning real estate crisis. It attracted interest on the Hill, but didn't make it into the final mortgage relief programs, which ultimately helped far fewer people than envisioned.
Frustrated with the feds, Hockett started throwing around the idea with a law school friend of his, a former Rhodes Scholar and banker named John Vlahoplus. They decided their plan could better be accomplished by states and municipalities. To do that, they'd need money.
The day before Richmond's city council meeting, on the steps of San Francisco's City Hall, Democratic City Supervisor David Campos held a news conference to announce his support for Richmond's plan. Backed by homeowners bearing the wonky slogan, "We need principal reduction," speakers railed against banks like Wells Fargo.
"For the rich, eminent domain works," preached the local Archbishop, Franzo King. "But when the poor or black or brown people see it as a solution to a problem the banks don't feel like dealing with, we're on the wrong foot. We're going to put these banksters on the run!"
At the edge of the sidewalk, a man with a white beard, baseball cap and sunglasses leaned against a lamppost, watching quietly. He's actually the guy responsible for it all: Steven Gluckstern, a former insurance executive who had teamed up with Vlahoplus to co-found Mortgage Resolution Partners, the firm that's lining up the capital -- from hedge funds, for instance -- to buy any mortgages that Richmond might seize. After that happens, Mortgage Resolution Partners would help the homeowner refinance through a Federal Housing Administration loan, and earns a $4,500 fee per successful transaction.
Gluckstern knows the process is more complicated than the ralliers are making it out to be -- for one, the banks pushing back don't own these mortgages, but they are obligated to act on behalf of the investors who do.
Even so, "it's helpful to have a bad guy," Gluckstern says. Wells Fargo, headquartered across the plaza, makes a good one. This is the kind of activism that was missing in San Bernardino County, one jurisdiction to have seriously considered using eminent domain and opted against it after a sustained opposition campaign and little community support. Besides, he says, the financial services and real estate industries are going all out.
"The opposition is so vehement because it's the 'shoot-the-puppy' strategy," Gluckstern said, in his shiny Volkswagen SUV on the way to his storefront personal office in a cute neighborhood in the southern part of the city (Mortgage Resolution Partners used to maintain an office downtown but closed it to save money). "If this can take hold in one community, and other communities see that it can happen, and the sky doesn't fall, and people see that homeowners can be kept in their homes, you're going to see the tidal wave, which the other side's figured out."
That's an accurate read of the situation. In court filings, the banks suing Richmond estimated that investors stood to lose $200 million if all eligible city homes received write-downs. Fannie Mae alone says that if the program were extended nationwide, the government-owned mortgage giant could theoretically lose $24 billion. Even if this crisis is unique and there's no reason Richmond would need to use eminent domain in the future, as Gluckstern argues, the industry would much rather not see anybody else use it even once. Besides, they worry, what's next: Underwater car loans? Student loans? Credit card debt?
"There is no doubt, investors will not put capital to work in a jurisdiction where there is a threat of a taking," said Tim Cameron, the Securities Industry and Financial Markets Association's point person on the issue. "We're going to go to those with the best credit, and where the belief in property rights are sound."
For Gluckstern, the bigger problem is getting any support from entities in the Washington establishment whose opinions carry weight. The Federal Housing Finance Administration has warned it will stop Fannie Mae and Freddie Mac from lending in jurisdictions that use eminent domain to seize mortgages. Since private lending is at a standstill, that would effectively put Richmond's real estate market into a deep freeze.
While national fair housing organizations condemned FHFA's threat as "redlining," since it would cut off credit to a disproportionate number of Hispanics and African Americans, other big groups -- such as the National Housing Conference, National League of Cities and National Housing Institute -- have been skeptical of the city's approach as well.
"I just don't think cities are going to want to take up the work," said Linda Couch, policy director at the National Low Income Housing Commission. "Implementing eminent domain and buying up the properties is the easy part. How do you know that a city manager is going to know how to right size a mortgage? Does the city then become responsible for evicting people if things don't work?"
Even credit unions, which made lower-risk loans and are rooted in their communities, decry the plan. David Green is president and chief executive of the Contra Costa County Federal Credit Union, which serves city, county and state employees. He says he's maintained strict underwriting standards and has foreclosed on only three homes in the past few years. Green says he doesn't think investors should be bilked through eminent domain.
"I don't agree with what they're doing, especially since it hits so close to home," Green said. "I think their heart's in the right place, I just think it's the wrong vehicle for doing it."
Gluckstern has made the rounds in Washington, too, with little success: Richmond's own congressman, Democratic Rep. George Miller, only reluctantly sent a letter encouraging Bank of America to do more principal write-downs.
Gluckstern, frustrated by the timidity, is starting to sound like an Occupy Wall Street person himself.
"I think most politicians don't give a [expletive] about the middle class," he said. "I think they wish they'd go away. It's hard to know what to say to people about the fact that the rich keep getting richer -- how long do you think we can sustain that? It's way too unequal, and the consequences for my grandchildren are going to be severe." It seems he's given this spiel before, including the doomsaying conclusion.
"And then what happens? The French Revolution."
Neutral parties are hard to find in Richmond.
Mortgage Resolution Partners has lots of investors to pay back (it's spent more than $7 million promoting the plan and paying Richmond's legal fees).
Underwater homeowners are eager to see their debt reduced and loans locked in at a lower interest rate.
The pension and mutual funds that own the securitized mortgages don't like the precedent of government seizing their assets.
Real estate agents don't own the homes or the mortgages. They mostly care about a healthy market. But having decided eminent domain would be a disaster, they signed on as ground troops for the opposition. In Richmond, the local Realtors' association detailed 30-year veteran Jeff Wright to lead the charge.
As part of that mission, Wright offered a tour of the city to prove that Richmond isn't the hardscrabble suburb it's been made out to be -- and that it doesn't need to take the kind of drastic measures the city council is contemplating.
Wright pulled up to the El Cerrito Bay Area Rapid Transit railway station in a silver Cadillac and shades, wearing a starched shirt with gold cuff links and a carefully tended goatee, easily recognizable from the glossy attack mailers warning that Wall Street was coming to "take a bite out of" Richmond's homes. First stop: The house in the lower-middle-class neighborhood of South Richmond where he grew up. Wright scans for boarded-up houses and finally finds one.
"If you see a news account of Richmond, they take the picture here, because that gives the slant of poverty and not looking so great," he said, punctuating his sentences with pauses and hand gestures. Then we drove west toward Point Richmond, which has breathtaking views of San Francisco Bay and large houses with expensive cars in their driveways.
"Did you know that some of the houses on the list are in here?" Wright asks, affecting astonishment. "Guess they need some help, too."
That's one of the pro-eminent domain contingent's public relations failures. They included all owner occupied underwater mortgages locked up in private label securities on their initial list of 624, even those that were current on their payments. While activists and city officials have said they'd probably re-evaluate whether the borrower really needed help before seizing the mortgage, opponents have successfully used the cluster of listed homes in wealthy neighborhoods to characterize the whole program as an indiscriminate bailout for the wealthy.
Our tour of not-struggling Richmond continued.
"OK, this is a country club," Wright said, pausing for effect as we passed a gated golf course. "The Richmond Country Club." And then, climbing the heights behind it: "This is called Country Club Vista. Country Club Vista: Why? Because it overlooks a country club. This is poor, impoverished Richmond," he finished, chuckling to himself.
The Realtors' opposing argument breaks down into three basic parts.
The first is self-interested. They're terrified of giving lenders and bond buyers any reason to look twice at Richmond, which is what appeared to happen when nobody bit at the $34 million bond issue it floated in July. Wright uses a grocery store analogy to explain his fear.
"All prices being the same, if I reach for a can of beans and there's a dent in the can, you know what I do? I put it back on the shelf and get the can that has no dent in it," he said. "The contents might be OK, but I don't want the dented can. In a sense, Richmond's bonds are like a dented can."
Is that actually how bond buyers operate? Yes and no. Deborah Lucas, a municipal finance expert at MIT's Sloan School of Business, points out they could see the threat of eminent domain as a signal that the bonds are risky, even if they buy Gluckstern's argument that a seizure would never happen again. At the same time, though, bond markets are broad and deep. "The effect of a boycott by some investors would only be to drive up yields, which would attract others to take their place," Lucas said.
The second sort of argument the Realtors make is ideological. Richmond conservatives also fought Green Party Mayor Gayle McLaughlin on a proposal to tax soda, which Wright sees as evidence of a "nanny state," just like intervening to break a contract with a lender to help out someone who shouldn't have taken out that loan in the first place, he says.
"Did you have to buy that property? No, you didn't," he said. "If people can show me where their signature was forged on the document, or you can show me you had to sign under duress, lender put you in a chair, tied you up, put a gun to your head and said 'you're going to do this loan,' I will shut the hell up and go to the other team."
Advocates respond that personal responsibility is irrelevant: In a world where more people held good jobs and banks had lower standards, paying a high price seemed perfectly reasonable. After all, many people had fared well in a booming housing market.
Besides, the thinking goes, in the aggregate investors would be better off getting fair market value now than losing the entire value of those securitized loans that tend to fail at about a 30 percent higher rate than regular bank-owned ones.
The last argument has to do with what's good for the neighborhoods. Wright figures that there's no inherent harm in a foreclosure -- if someone defaults and leaves, the market is hot enough that someone else will take their place.
"So now the family that got foreclosed on. They're gone, that's unfortunate, but now another family's in there," he said. "So it's transitioned in the same way as my neighbor's, who's put his house up for sale. Transition is transition. One's voluntary, one's involuntary. What harm is caused to the community by one family moving out and another family moving in?"
But this is the biggest point eminent domain advocates have to drive home: That foreclosures are so devastating to a community, and more of them are so inevitable, that it's worth risking the wrath of markets to make them go away. So they'll talk about how foreclosures lower property values and therefore tax revenue, replace stable homeowners with investor-owned homes full of shiftless renters and demoralize a community. In Richmond, it's been enough to convince city leaders they have little left to lose.
The tragic thing, for Richmond and other cities, is that even if they decide to use eminent domain, it will be too late for many of the worst affected. Two thousand Richmond homes have gone into foreclosure in three years, and about 1,600 more homes with underwater mortgages are wrapped up in private-label securities. Meanwhile, housing values are on the rise, which means that they're less valuable for investors that might supply the funds to buy them from those securitized pools.
Nationally, the situation is similar; the plan wouldn't help 4.4 million households that CoreLogic estimates have foreclosed since the beginning of the financial crisis in September 2008. Another 4.5 million investor-owned loans are still underwater, by Hockett's estimates.
Some Richmond residents have adapted to the new normal.
Take Ricardo Cabral. He lost his house in Oakland to foreclosure eight years ago after losing his job in construction, his back wracked with the pain of decades as an ironworker. He moved with his wife and daughter to Richmond, where they rented a house from a friend until that house was foreclosed on as well.
They found another place in the city's notoriously run-down and dangerous Iron Triangle, renting it for $1,200 per month. Cabral, who stays home with four chihuahuas while his wife goes to work in Marin County, keeps the lawn neat and tidy. They try to ignore the gunshots that ring out at night and figure they'll stay as long as they can, having given up on the idea of actually buying a house ever again.
"I don't own the home, but I'm very happy," Cabral said. "I'm here to stay in Richmond, not Oakland."
Cabral is hopeful that the city will be able to pull off its plan, but he's skeptical. "If it comes true for the people, hooray for them, hooray for Richmond," he said. "If you can back your story up and say, 'Hey, you're for the underdog, you're going to help people keep their homes,' I'm all for Richmond. Right now, you're just a piece of paper saying this is what you're going to do, and you ain't done nothing, yet."
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