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Edward Burg, a partner with Manatt, Phelps & Phillips LLP in Los Angeles, represents property owners in eminent domain cases.

Seizing Underwater Mortgages: An Idea That's All Wet

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The latest municipal attempt to seize underwater mortgages by eminent domain is an abuse of this most awesome governmental power.

The plan is being pushed by San Francisco-based Mortgage Resolution Partners, which recently entered into an agreement with the city of Richmond, Calif. And the city has sent offers to several lenders to buy over 600 underwater mortgages, threatening to use its power of eminent domain to acquire the mortgages if the lenders do not sell voluntarily.

Under the plan, MRP will be paid $4,500 for each mortgage acquired by eminent domain. MRP told Richmond that the city itself will be paid 5% of each new loan that replaces the underwater loans. Seems there's plenty of money to be made in underwater mortgages.

The power of eminent domain allows public entities to take private property for a public use, upon payment of just compensation to the owner. It is true that over the years, the Supreme Court has left little of the "public use" clause of the Fifth Amendment. But MRP's plan is based on shoddy math that won't work under the laws of eminent domain.

The plan presumes that a lender owed $300,000 on a mortgage will simply accept $160,000 as the value of the mortgage because the underlying property is now worth only $200,000.Like any other property owner, the lender is entitled to be paid fair market value for its property. California law defines fair market value as the highest repeat, the highest price that would be agreed to between hypothetical fully informed buyers and sellers of the property at issue.

Valuation is the key to every eminent domain case. The owner demands more and the government offers less. Since most of the loans that Richmond has offered to buy are performing loans that's right, the homeowners are current the value of the performing income stream will surely not be capped by the depressed value of the security.

Put simply, there's a lot to fight about here, and count on the lenders fighting. Yet MRP's plan budgets a grand total of $1,950 for legal expenses for each eminent domain case. On what planet will such inexpensive lawyers be found?

MRP seems to think that if the city uses California's "quick take" procedure, it will all be over quickly. Not so. A "quick take" procedure allows the government to take early possession of property based on its estimate of value, then build the project and pay the balance of compensation when the case is over. Even assuming the city can take "possession" of a loan whatever that means the lender's lien will remain on the property until the final order of condemnation is recorded, the very last step in the case.

Eminent domain cases frequently take about two years to get to trial (especially with underfunded courts), and an appeal will add another two years to the timetable. There is no provision allowing homeowners to stop making their mortgage payments during that four-year period. And good luck trying to sell the property during that time.

MRP told the City that it will find a new lender willing to lend $190,000 to replace that pesky $300,000 loan (the one MRP thinks can be bought for $160,000). But the new lender will not have a first-position lien until after the case is finally concluded, possibly up to four years. Perhaps those unprotected lenders reside on the same planet as those underpaid lawyers.

MRP's plan is entirely based on capturing the fictional $30,000 spread between the $160,000 it thinks the present lender will voluntarily sell the loan for and the $190,000 it thinks the new lender will fund. Without that spread, nobody makes anything and nobody can pay the transaction costs of the process.

Not to worry, says MRP. If things don't work out, the city can abandon the taking. One problem under the law of eminent domain, the city will owe the lender its attorneys'fees upon abandonment.

The plan is a morass of problems, based on numbers that do not add up in the real world. Eminent domain was meant to build roads, schools and other public projects. It wasn't intended to solve society's perceived problems. The city of Richmond would do well to give up on this wacky idea, lest it find itself underwater in a lake of debt that it does not understand and has not fully thought through.

Edward G. Burg is a partner with Manatt, Phelps & Phillips LLP in Los Angeles. He regularly represents property owners in eminent domain cases.

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Comments (1)
The nation is affected by home loans that are underwater, where the proprietors owe more than the property is worth. It's approximated that up to one-third of houses are. However, a California mortgage company has the novel notion of using eminent domain to "condemn" the home loans and force a refinance.
Posted by blairjac | Saturday, September 14 2013 at 4:47AM ET
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