Guest commentary by Neil Baron
Municipalities are threatening to use eminent domain (the right to take property for the general good) to seize mortgages that are greater than the value of the home but current in their payments, from mortgage pools that have been securitized privately.
The issue of eminent domain is presently being raised in Richmond, California, where the program is being pushed by a private company, Mortgage Resolution Partners (MRP). The company plans to purchase the loans from the City of Richmond at, we estimate, 80% of the home’s value because that value would reflect distressed properties and would not be decided by negotiation between seller and buyer, but instead by the government’s agency or a local court.
Although local governments may be sincere in their belief that eminent domain will benefit homeowners, that belief is short-sighted because eminent domain will ultimately increase the cost of or deny access to mortgages for all their borrowers and limit the business of their lenders.
This use of eminent domain is likely to: (i) result in losses to investors in private residential mortgage backed securities (RMBS), (ii) make it difficult and expensive to attract private capital to restart the private mortgage markets at a time when Freddie Mac and Fannie Mae are to be wound down and (iii) increase the cost of private capital that President Obama wants to absorb losses on government guaranteed RMBS before the government has to pay. And while the use of eminent domain could benefit the few homeowners whose mortgages are seized, the tactic would increase the cost of all mortgages in locations using eminent domain in this way. As certain rating agencies, such as Fitch Ratings, note, this use of eminent domain could even prevent lending in municipalities using or contemplating the use of eminent domain to seize mortgages.
Laurie Goodman of Amherst Securities concludes that holders of private RMBS would fare very poorly because: (i) the 80% valuation would reflect distressed properties resulting from defaulted mortgages, while the seized mortgages would be current and less likely to be distressed, (ii) the homeowners would have FICO (i.e. credit) scores of 680 to 710 and meet reasonable debt to income tests, (iii) the original LTVs would be 78 to 81, which creates perceived equity in the home – an important disincentive to default, (iv) investors would lose the benefit of rising home prices, and (v) the loans seized would be based on full documentation and therefore be less likely to default.
Lawsuits by major asset management firms on behalf of their investors, and Fannie Mae and Freddie Mac against the city of Richmond, California claim that the city’s use of eminent domain could lose investors $200 million or more.
The program, however, would be quite profitable for MRP because it would purchase the mortgages at 80% of the home’s value and refinance them at FHA’s 97% LTV at current interest rates – now around 4.5%. MRP could then sell the refinanced loans at a profit. So eminent domain used as proposed would seem to be used for MRP’s good as opposed to the public good.
Not surprisingly, three members of Congress have urged HUD not to allow FHA to insure the refinancing of mortgages acquired through eminent domain. HUD responded that it would wait to see the impact on FHA and the mortgage markets generally.
The three largest rating agencies have opined that eminent domain will increase the risk of loss on RMBS. S&P stated that it would increase the uncertainty of private-label RMBS, alter the nature of the mortgage contract between borrowers and lenders, and affect the ratings of existing securities and RMBS analysis.
FHFA has stated its view that the use of eminent domain to seize mortgages presents a clear threat to the safe and sound operations of Fannie Mae, Fannie Mae, Freddie Mac and the Federal Home Loan Banks. FHFA added that it may direct these regulated entities to limit, restrict, or cease business activities within any community employing eminent domain to restructure mortgage loan contracts.
Although local governments may be sincere in their belief that eminent domain will benefit homeowners, that belief is short-sighted because eminent domain will ultimately increase the cost of or deny access to mortgages for all their borrowers and limit the business of their lenders.
Also, governments can’t argue that they are helping homeowners stay in their homes because the targeted homeowners are current in their mortgage payments and not at risk of foreclosure. Instead, the cities and MRP are encouraging and allowing homeowners to breach the terms of their mortgages.
MRP has characterized eminent domain as a program that will help Main Street and hurt Wall Street. But virtually every public employee retirement plan of any size (including CalPERS, significant because California is where the proposed use of eminent domain was first introduced) invests in RMBS, as do many fixed income mutual funds. Many millions of Americans depend on these funds for their daily expenses and their retirement. It would seem that the millions Americans who will be hurt by the proposed use of eminent domain are part of Main Street, while MRP, who will benefit from the program, is part of Wall Street.
Neil Baron has over 30 years of experience in the municipal bond industry, including working with rating agencies and as a consultant.
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