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Mortgage investors’ inevitable constitutional challenge to eminent domain

Mortgage investors’ inevitable constitutional challenge to eminent domain

On Tuesday, the small California city of Richmond announced that it has sent notices to 624 homeowners whose houses are worth less than they owe on their mortgages. Richmond said it intended to buy their mortgages for 80 percent of the fair value of their houses and to help them refinance with new, more affordable mortgages. In the event homeowners don’t want to participate in the program, Richmond said it would use its power of eminent domain to seize the mortgage loans.

Yes, the much-discussed eminent domain mortgage seizure idea is finally being realized, despite vehement opposition from just about the entire financial industry. It’s been more than a year since a San Francisco outfit called Mortgage Resolution Partners first floated the concept of partnering with troubled cities to reduce foreclosures by using the city’s eminent domain power to seize mortgages of underwater homeowners in the name of the public good. (MRP’s role is to provide cities with capital for the eminent domain purchases, issue modified mortgages to homeowners and then bundle and resell the new loans as mortgage-backed securities.) Proponents have pitched the plan as a public boon, a way to keep homeowners in their houses and preserve neighborhoods that would otherwise be blighted with foreclosures. The concept was alluring enough that over the last year, officials in several California cities, as well as North Las Vegas and even Chicago, have toyed with using eminent domain to stave off foreclosures.

Before Richmond, however, all of the cities that considered the scheme have been dissuaded, in part by concerted financial industry opposition. Investors in mortgage-backed securities hate the eminent domain idea. No mystery there: The vast majority of the mortgage loans that cities want to seize belong to MBS trusts. When cities talk about buying mortgages for 80 percent of the current value of a house, they’re not accounting for the value of the seized loan to the MBS trust that actually owns the mortgage, especially because these eminent domain proposals call for the takeover of performing loans, not mortgages on which homeowners have already defaulted. (More than 440 of the homeowners that received notices from the city of Richmond are up-to-date on their mortgage payments.) So as Timothy Cameron, the head of the Asset Management Group of the Securities Industry and Financial Markets Association, explained to me on Thursday, MBS investors believe that they’re twice injured by mortgage seizures under eminent domain plans. First, they’re shortchanged on the value of the revenue stream from a performing loan; and second, they’re damages by the decline in the value of their mortgage-backed securities, which are worth less when performing loans are terminated.

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