Scam or Savior?
Progressives are cheering Richmond's eminent domain solution to underwater mortgages. But is it too good to be true?
I was in the Bay Area last week, snooping around Richmond to try to get a handle on the city's controversial plan to help underwater homeowners modify for their loans by seizing them with eminent domain.
Richmond is a poor industrial city just north of Berkeley with some stunning views of San Francisco and the Golden Gate Bridge. The reason it's so poor is because of a massive Chevron refinery that dominates the town and which periodically spews toxic fumes, requiring thousands of people to be evacuated. The city is home to 200,000. For as long as I've known about it, the name "Richmond" has been synonymous with "ghetto." And now the city — in the middle of a booming Bay Area real estate market — is synonymous with "underwater mortgages." Almost half of all Richmond residents with mortgages owe the bank more than their properties are worth — sometimes crushingly more.
It's a serious problem for the local economy, sucking money out of the community and making it impossible for people to sell their homes. Ultimately, it's a problem that leads to default, foreclosure, more blight, reduced property tax base for the municipal government and shrinking government services. It's a downward spiral that could be softened by mortgage modification, something banks and services have been unable and unwilling to do.
So Richmond, led by its Green Party mayor Gayle McLaughlin, is tackling the underwater problem by flexing the city's power of eminent domain.
Under both U.S. and California constitutions, municipalities are allowed to seize — forcefully buy at market prices — private property in the interest of the greater public good by invoking the power of eminent domain. And that's exactly what Richmond intends on doing.
The plan is simple:
- The city will force current holders of several hundred underwater mortgages (which are securitized and owned by various institutional investors) to sell at fair market prices.
- It will then turn around and sell these homes to new investors.
- These new investors will arrange new mortgages/loans for homeowners that reflect the current, much lower market-level value of their properties.
- Everyone is happy.
To do this, Richmond is partnering with a for-profit financial company called Mortgage Resolution Partners (MRP). Or at least that's the official line. Actually it was MRP who came up with the eminent domain scheme and sold Richmond on using it. MRP agreed to handle the technical details of the plan in return for a fee of $20,000 a property, which would be split between MRP and its investors. Richmond also stands to make a little dough in the process as well — maybe as much as $10,000 a house.
The plan is supported by a wide range of grassroots prog, lefty and labor groups, who see it as a real solution the underwater mortgage crisis that could be replicated all across America if successful. Progressive news orgs, including The Nation and Mother Jones, have been boosting Richmond's plan. MoJo's Josh Harkinson described it as Wall Street's worst nightmare: "The outcome of the foreclosure crisis—and the fate of many investors who bet on it—may hinge upon a city council vote tonight in a little-known working-class suburb."
The banking sector is very clearly against this, and a coalition of banks, investment firms and financial companies filed a federal lawsuit to try and stop the plan from moving forward. But their lawsuit was thrown out in earlier in September.
From the outside, it looks like the plan is gravy. Who doesn't want to stick it to Wall Street fraudsters and help the little guy, all while generating a little cash for everyone involved?
On closer inspection, however, Richmond's grand eminent domain plan starts to look more than a little shady.
Yves Smith, who's worked for McKinsey and Goldman Sachs and understands the world of finance from the inside better than just about anyone on the left/progressive side today, has fiercely come out against Richmond's eminent domain plan, which she sees as a sophisticated scheme to poach profitable mortgage-backed securities from institutional investors like pension funds for the benefit of a private equity firm.
Y'see, about 75 percent of the 624 Richmond mortgages targeted for an initial test-run of MRP's eminent domain scheme are what's known as "performing" — that is, they are mortgages where homeowners have never missed a payment or have had problems of any kind. Put another way: the vast majority of the underwater mortgages that Richmond wants to seize had monthly payments made on on time, month after month. Reuters' Felix Salmon described it this way: "MRP is looking to buy up only seasoned, performing mortgages: precisely the ones which are worth the most money, and which don’t present much of a systemic danger…"
Sure, like all underwater borrowers, these homeowners could choose to walk away and default on their loans. But it's been five years since the real estate crash, and they have not done so yet. So there is no indication that they would do so any time soon, or ever. And until they do, these mortgages are as good as gold: they provide a guaranteed cash stream for investors. That means Richmond's eminent domain plan would snatch a performing investment from someone and giving it to someone else.
The way the Nation, Mother Jones and other prog media supporters describe the plan, you'd think that the only ones being screwed here are the same banks and Wall Street hucksters who screwed us and made a killing on the real estate bubble. So who cares if they are punished by having their profitable investments snatched out from under their noses?
There's only one problem with this logic: Banks don't own these mortgages. They just service them. The loans targeted for eminent domain by Richmond and MRP have been securitized and are now owned by various institutional investors.
Who are these "institutional investors?" That's a good question. Short answer: no one really knows. But there is a very good chance that many of these institutional investors are endowments, mutual funds and pension funds, particularly public sector employee pension funds. That means that Richmond eminent domain plan could very well be gutting pension funds and screwing over workers for the sake of some private equity guys, all under the guise of a populist uprising that helps underwater borrowers.
Who's right? Who's wrong? Are Richmond's Green Party mayor and her prog supporters a bunch of dupes being hustled by smooth talking Wall Street hucksters? Or have these smooth talking Wall Street hucksters found a way to screw other, bigger Wall Street hucksters in a way that actually produces some benefit to society?