California Mortgage Grabs Are a Terrible Idea
On September 17, Bloomberg.com published an article titled California Mortgage Grabs Are a Terrible Idea.
California Mortgage Grabs Are a Terrible Idea
During World War II, Richmond, California, was the home of legendary shipyards that could build a single Liberty cargo vessel in a matter of days. Now it's mostly known for hosting a Chevron refinery and for being one of the most dangerous cities in the United States.
This month it also became the first municipality to formally express interest in using eminent domain to seize certain mortgages held in private-label securitization trusts and then restructure them. Not only is this probably unconstitutional, a thorough examination of the facts shows it is a bad idea for the city and deeply unfair to the current owners of the targeted mortgages.
Richmond's city council is hoping to repair some of the damage caused by the housing bubble. According to Zillow, home values collapsed by two-thirds from the beginning of 2006 until the beginning of 2012. While home prices have recovered somewhat since then, about 38 percent of mortgages in Richmond (7,000 loans) are still underwater, according to RealtyTrac.
Securitization is partly to blame. During the bubble years, mortgage originators sold trillions of dollars of loans to banks that then put them into trusts, which then issued securities to investors with different appetites for risk. Pension funds, insurers, and mutual funds generally bought the supposedly less-risky senior pieces, while the junior securities were usually purchased by hedge funds and bank trading desks. The structure of these trusts led to "tranche warfare" between the holders of senior and junior securities once the housing market turned south. Making matters worse, the mortgage servicers often preferred foreclosing on delinquent borrowers to reducing their principal balances. The net result was millions of unnecessary foreclosures, which in turn flooded the market with excess supply.
Richmond is trying -- belatedly -- to make up for the government's failure to intervene with a plan concocted by Cornell law professor Robert Hockett. He thinks states and municipalities should buy underwater loans owned by securitization trusts and then refinance those loans into new Federal Housing Authority-guaranteed mortgages. The theory is that this will increase consumer spending by lowering monthly payments and reduce the risk of default by giving borrowers equity in their homes. There is nothing wrong with this part of the plan.
The controversy comes from Hockett's additional recommendation that local governments use eminent domain to seize loans at prices far below their face value. This is ostensibly necessary to minimize the burden on local taxpayers. It also happens to create a sizable profit opportunity for the clever investors who founded Mortgage Resolution Partners, which is paying all of Richmond's legal fees and has picked the 624 mortgages the city is interested in acquiring.
Those 624 loans have some interesting characteristics. According to CoreLogic (sorry, no link), 52 percent of them loans have already been modified at least once. Interest rate reductions and principal forgiveness have cut those borrowers' average monthly payments by about 54 percent. Federal Reserve researchers believe this is economically equivalent to the principal write-downs proposed by MRP. In fact, about 220 of the 624 loans targeted by MRP aren't even underwater any more.
The default risk on the remaining loans -- about 6 percent of the 7,000 underwater borrowers in the city -- also seems minimal. More than two-thirds have perfect payment records. It's hard to believe that anyone who refused to walk away from his mortgage when house prices were collapsing would suddenly decide to default at a time when Richmond home values are increasing by 29 percent a year. This is why the holders of the mortgages deny MRP's assertion that the underwater loans are actually worth much less than their face value.
To view the article in its entirety, please click here.
Safeguard Properties is the largest mortgage field services company in the U.S. Founded in 1990 by Robert Klein and based in Valley View, Ohio, the company inspects and maintains defaulted and foreclosed properties for mortgage servicers, lenders, and other financial institutions. Safeguard employs approximately 1,700 people, in addition to a network of thousands of contractors nationally. Website: www.safeguardproperties.com.