Richmond is a heavily working class, Latino and African-American community of 106,000 across the bay from San Francisco, north of Berkeley. During the second world war, its shipyards set records for the speed with which they turned out the Liberty supply ships that made Allied victory possible.
Today, the city is in the news for the potentially precedent-setting tactics it has adopted to reduce the mortgage debt of homeowners who bought at the top of the market on the theory it would go up forever and now owe considerably more than their properties are worth.
The median Richmond house price having fallen from $450,000 in January 2006 to $220,000 currently, just over half of all mortgage bonds in the city are said to be underwater. The city’s management, led by the only mayor in the country who is a member of the Green party, has said that if lenders are not willing to restructure mortgages to reflect current property values, Richmond will do the job for them through compulsory purchase of the bonds at “fair market prices”.
The city will, in effect, force creditors to sell troubled mortgages at a court-adjudicated discount to a purpose-built private company, Mortgage Resolution Partners, launched by former Rhodes scholar John Vlahoplus who has been raising the capital to buy them.
Eminent domain, the US term of art for the compensated taking of private property by the state, is as expressly permitted under the American constitution as it is by South Africa’s. The Supreme Court long ago determined that almost any kind of property could be seized so long as a public purpose was served.
The court has been equally generous in its interpretation of public purpose. In 1984, the nine-member bench ruled 8-0 that Hawaii could use eminent domain to expand land ownership beyond a narrow elite in the name of fairness and social harmony. More recently, the court said the city fathers of New Bedford, Connecticut, had every right to take land from one private owner and sell it to another set if the latter’s for profit use of it would generate more jobs and tax revenues.
Richmond says that its use of eminent domain would serve several public purposes. It would forestall the neighborhood blight and attendant loss of property values and taxes which result when homeowners abandon properties they can no longer afford or are foreclosed upon. The local economy would gain from improved disposable incomes and increased home sales. Investors — mostly hedge funds and institutions — in whose portfolios the debt now sits would also stand to benefit.
None of the mortgages in question – there are 642 — is owned by a single lender. No sooner were the loans originated than they were sold on, carved up and repackaged. This was the notorious financial alchemy by which loans extended to uncreditworthy borrowers by predatory lenders were converted into AAA-rated securities, helping pump up the bubble that popped in 2008.
With scores of different investors owning slices of each underwater mortgage, there is what housing economist Robert Shiller calls a collective action problem. Home loans held in mortgage-backed securities (MBS) are more likely to default than those held by traditional lenders. But when each individual mortgage has so many different owners, the difficulty is getting their assent to restructure. The middlemen who collect fees for seeing that mortgage payments flow to MBS-owners have little incentive to help. By forcing everyone’s hand, eminent domain may solve this problem in the interest of creditors for whom restructuring would make sense.
Wells Fargo and Deutsche Bank take a different view. They have sued, so far unsuccesfully, to stop Richmond before it even starts. For them, the idea of using eminent domain to enforce debt forgiveness is understandably alarming. It could metastasize across the country – and loan classes.
The Obama administration, whom critics accuse of having bailed out Wall Street at the expense of Main Street, is no fan of the Richmond approach, despite some initial enthusiasm when the founders of Mortgage Resolution Partners canvassed candidate Obama for support in 2008.
Local real estate agents don’t buy it either. They see lenders making it more difficult to get a mortgage in Richmond, depressing property prices and ruining their business. The city recently tried to raise $34 million on the municipal bond market. In what many see as a coordinated investment strike, there were no takers.
Then there are those like Reason, the libertarian magazine, who view Richmond’s use of eminent domain as crony capitalism – politicians using to power of the state to transfer stolen assets to their friends.