Despite an initial win in federal court, will Richmond first have to prove that loans on over-mortgaged homes in its city are “trapped” to meet the “blight” criteria of California redevelopment law? A recent study by the Wall Street Journal indicates that Richmond would have to prove loans on over-mortgaged properties are “trapped” before they can justify there is public necessity to take the loans.

A “trapped” loan is where a government secondary mortgage market lender such as Fannie Mae or Freddie Mac won’t buy up sub-prime mortgages from primary lenders or other secondary lenders.  Therefore, homeowners with over-mortgaged homes cannot refinance by taking advantage of HARP or other mortgage payment programs. Their high-interest rate loans are “trapped” without any ability to refinance.

Richmond would have to prove “blight”

Wall Street Journal reporters Michael Corkey and Al Yoon sampled 36 out of 1,726 loans left in mortgage loan pool called CWABS Asset-Backed Certificates Trust 2006-7.  CWABS is an abbreviation for Country Wide Asset-Backed Securities; 836, or 48 percent, of homeowners in CWABS 2006-7 are current in their payments.  About half of the mortgages in CWABS 2006-7 are from California and Florida.

The U.S. Securities and Exchange Commission presently manages this loan pool.  Originally, the loan pool consisted of 5,954 mortgages.  The Journal did not report if the 4,228 loans no longer part of the pool were foreclosed, paid off, or refinanced by other lenders.

To undertake its eminent domain loan payment reduction program, Richmond must file a Resolution of Necessity in Contra Costa County Superior Court justifying the reason why taking mortgages out of a lender’s loan portfolio serves a public purpose.  Eminent domain law gives wide discretion to governments as to what qualifies as public purpose.  However, cities must typically prove “blight” to justify the use of eminent domain for economic purposes. Under California law blight is defined as:

“An area that is predominantly urbanized…and…it constitutes a serious physical and economic burden on the community which cannot reasonably be expected to be reversed or alleviated by private enterprise or governmental action, or both, without redevelopment.”

However, there is no public necessity to take loans on over-mortgaged homes where the homeowners can avail themselves of loan reduction programs, can short sale their homes for less than the loan balance, or are in default and can be foreclosed. Conceivably, all those actions would prevent or alleviate neighborhood blight in the long run.

There may be a private necessity to renegotiate an over-mortgaged home loan.  But aggregating the private necessity of all the over-mortgaged home loans in Richmond does not necessarily make a public necessity.

The City of Richmond incurred $7.9 million in 2012 in extra costs to prevent foreclosed homes from “blighting” neighborhood home values.  Therefore, it would only be those homes where there would be a public necessity to prevent blight. But those homes are no longer over-mortgaged.

Loans on over-mortgaged homes where homeowners are making payments are not causing “blight.”

To further learn how mortgages become “trapped” one has to understand how the primary and secondary mortgage markets work.

The secondary mortgage market

The secondary mortgage market is for the sale of securities or bonds in which the collateral is a pool of mortgage loans.  There are five layers of participants in the government-regulated mortgage market:

1) Borrowers.  These are homeowners whose loans have been re-sold by their bank to secondary banks;

2) Primary lenders or loan originators consisting of banks and mortgage banks;

3) Aggregators or secondary mortgage market banks like the federal government’s Fannie Mae  and Freddie Mac. Because of the risk of holding loans that might default, government-sponsored aggregators hedge their risk by “securitizing” them into bonds and other debt instruments.

4) Securities Dealers who sell the re-packaged loans to investors; and

5) Investors, which could be pension funds, insurance companies, and foreign governments.

One of the objectives of this many-layered loan system is to buy the loans off of the primary banks so they can make more loans to homeowners.  Each layer of the secondary mortgage market buys pools of loans based on risk-based discounts.

In the case of the City of Richmond’s mortgage consultant, Mortgage Resolution Partners is a mortgage securities dealer that buys loans on discounts.  It believes that if Richmond can take the loans on over-mortgaged homes away from primary lenders by eminent domain, it can re-sell the loans to investors at a discount and pass that discount back to the homeowners.  Mortgage Resolution Partners would also provide a $46 million windfall to the City of Richmond.

But an unresolved question is: who pays the investors of the primary and secondary mortgage lenders for the difference in the balance due on the loan and the discount price in the securities market?  The position of the City of Richmond and its mortgage securities consultant is: It's not their problem.  They believe they can stick the investors of primary banks with losses because the market value of the loan is worth less in the securities market.

However, an unresolved issue is: Would over-mortgaged homeowners eventually be stuck with paying off the investors of primary lenders when the homes are sold at a windfall profit?

Eminent domain law explicitly requires that the property owners be made whole for any losses. But what happens to the investors of the banks that are holding the loans?  So the whole scheme by the City of Richmond may backfire.  Here is where “trapped loans” come into the picture.

“Trapped Loans”

The City of Richmond’s scheme is to offer loan reductions to homeowners who are current on their loans payments.  Richmond would even go so far as to reduce the loan balances on million-dollar homes, which obviously are not blighted.

Richmond has a point that the loans contained in CWABS 2006-7 are high-interest sub-prime loans. CWABS 2006-7 is a high-interest rate loan pool averaging 8.5 percent, but ranging as high as 15 percent.

However, for homeowners to avail themselves of government loan payment reduction programs such as HARP (Home Affordable Refinance Program), their loan must be guaranteed by Fannie Mae or Freddie Mac.  Fannie and Freddie refused to invest in bonds loaded with so-called subprime loans.  The buzzword in the mortgage industry for high-rate loans that can’t be refinanced due to government rigamarole is “trapped.”

Because lenders have limited offering HARP 2.0 loans to only their own customers, they can raise rates on other homeowners with trapped mortgages and earn more than the market interest rate.

This raises the question, however, whether an eminent domain action is the appropriate legal action to correct this situation?  The definition of economic “blight” cited above specifies that it is where an economic burden is inflicted on a community that can’t be reversed or lessened by the private or government sectors or both.  The only types of properties that would meet this definition would be those with “trapped” mortgages.  All other types of homeowners with over-mortgaged homes have either private or public options available that would reverse or alleviate community blight.

Legally complex eminent domain actions in California are usually handled by bifurcating the trial into a “legal issues phase” and a “valuation issues phase.”

Such a pathbreaking use of eminent domain by the City of Richmond could take as much as a year just to decide the legal aspects.  Because Richmond may not be able to easily establish “public necessity,” it is unlikely that a court would authorize the automatic taking of mortgages with the value issue to be handled later.

But whatever happens in California’s court system, the matter of “trapped mortgages” is going to have to be raised.

By Chris Reed

California Attorney General Kamala Harris is among the many Americans of all political persuasions who are outraged that few are taking the fall for the grotesque irresponsibility that led to the housing bubble, its collapse, and the recession of the past six years.

She sued quasi-federal mortgage-issuing giants Fannie Mae and Freddie Mac in December over their foreclosures of 12,000 homes in California. Last week, she targeted Standard & Poor’s over the credit-ratings agency’s high marks for many firms involved in the bubble.

But Harris, who is half black and half Indian-American, is doing more than a little grandstanding here. Like most politicians and most of the media, she chooses to ignore the coarse racial politics that led both George W. Bush and Bill Clinton to push policies that inevitably inflated the housing bubble. It’s the uncomfortable back story that is usually ignored in favor of the tidy narrative of evil Wall Street and supine regulators.

On June 17, 2002, Bush announced a drive to get 5.5 million minorities out of apartments and into their own homes. The primary method amounted to affirmative-action lending — eliminating down payments and loosening income requirements. As The New York Times noted in a 2008 analysis, Bush’s primary means of achieving this end was insisting that “Fannie Mae and Freddie Mac meet ambitious new goals for low-income lending.”

Against this backdrop, Harris’ insinuation that Fannie Mae and Freddie Mac were racially predatory looks grossly demagogic. This is from a Huffington Post account of her lawsuit:

“Harris also called on Fannie Mae and Freddie Mac to disclose whether they have complied with civil rights laws protecting minorities and members of the Armed Forces against unlawful convictions and foreclosures.”

So if affirmative action backfires, the quasi-government agency pursuing affirmative action under pressure from the president faces civil liability?

Clinton’s role in inflating the housing bubble was every bit as direct as Bush 43’s. In 1997, he appointed Andrew Cuomo, the current New York governor, to be secretary of housing and urban development. Cuomo had little banking or lending expertise, but he had a broad banking and lending agenda. Veteran journalist Wayne Barrett laid out his folly in a 2008 analysis in Village Voice:

“Cuomo, the youngest Housing and Urban Development secretary in history, made a series of decisions between 1997 and 2001 that gave birth to the country’s current crisis. He took actions that — in combination with many other factors — helped plunge Fannie and Freddie into the subprime markets without putting in place the means to monitor their increasingly risky investments. He turned the Federal Housing Administration mortgage program into a sweetheart lender with sky-high loan ceilings and no money down, and he legalized what a federal judge has branded ‘kickbacks’ to brokers that have fueled the sale of overpriced and unsupportable loans. …

“Perhaps the only domestic issue George Bush and Bill Clinton were in complete agreement about was maximizing home ownership, each trying to lay claim to a record percentage of homeowners, and both describing their efforts as a boon to blacks and Hispanics. HUD, Fannie, and Freddie were their instruments, and, as is now apparent, the more unsavory the means, the greater the growth.…

“Cuomo … did more to set these forces of unregulated expansion in motion than any other secretary and then boasted about it, presenting his initiatives as crusades for racial and social justice … .”

Somehow I doubt this coarse and depressing history will be mentioned by Kamala Harris, who is an utterly conventional California Democrat despite her exotic background and moralistic rhetoric. Wall Street did behave with gross irresponsibility, Standard & Poor’s did fail as a credit-ratings analyst, and thousands of other white-collar types did behave unethically. But the ethical failing that started it all was bipartisan racial pandering dressed up as the pursuit of “social justice.”

The result here in the Golden State:

“Latino and African-American homeowners in California have experienced foreclosure rates 2.3 and 1.9 times that of non-Hispanic white borrowers.  Latino borrowers alone make up 48 percent of all foreclosures.”

That is from a 2010 report by the California branch of the Center for Responsible Lending. How perverse that from 1997 to 2006, the Center for Irresponsible Lending was at 1600 Pennsylvania Ave.

By Wayne Lusvardi

Will Americans be protected from eminent domain abuses? Eminent domain is where the government takes someone’s property, usually for a government purpose, such as building a school or road. But sometimes eminent domain is abused to take private property and give it to a private company, such as a big-box store or housing development.

Last week, California Lt. Gov. Gavin Newsom’s told mortgage banks and agencies of the federal government to “back off” from their opposition to the use of eminent domain in California to take “underwater mortgages.”

In response, on Sept. 13 Rep. John Campbell, R-Irvine, introduced the “Defending American Taxpayers from Abusive Government Takings Act” (H.R. 6397).  It would block local governments from pursuing the condemnation of so-called “underwater mortgages,” as is being proposed in San Bernardino County and elsewhere in California.

Campbell’s bill would work with secondary mortgage market lenders Fannie Mae and Freddie Mac, the Federal Housing Administration and the Veteran’s Administration to bring about mortgage reductions. The Federal Housing Finance Agency, overseer of both Fannie Mae and Freddie Mac, had threatened to take action against the use of what might be called “submerged eminent domain” before Rep. Campbell proposed his bill.

Underwater mortgages are really “over-mortgaged” loans where the amount of loan owed on a property is much higher than the current market value of a home.

For example, Campbell points out that San Bernardino County’s proposal would provide an incentive to appraise properties with underlying seized mortgages as low as possible to increase their potential profit to mortgage re-financiers. Stated differently: profiteering would be submerged out of the scrutiny of the public in rigged real estate appraisals.  What might be called “submergible eminent domain” would be used for underwater mortgages.

Campbell called such schemes “atrocious, corruptive, irresponsible and unconstitutional.”

Another Difficulty — A Tax Bill for Mortgage Reduction

The civil war over the use of eminent domain to acquire underwater mortgages has gotten almost all the media attention.  What has received less attention is the pending expiration of temporary federal legislation passed in 2007 that suspended the tax liability of homeowners who receive mortgage reductions of up to $2 million.

In 2007, Congress passed the Mortgage Forgiveness Debt Relief Act, which expires at the end of 2012.  There is discussion to extend it, but Congress only has three months to act.  Newsom has made no known advocacy to extend the Debt Relief Act.  Instead he is championing the questionable use of eminent domain law to buy out underwater mortgages.

Creative Appraisals Proposed In-Lieu of Eminent Domain

Steven Gluckstern, chairman of Mortgage Resolution Partners, a private hedge fund proposing to condemn underwater mortgages, has proposed another “doozey” of a concept.  It would involve using creative appraisals instead of eminent domain to reduce mortgages.  Here is the Sacramento Bee described an example of his:

“A homeowner paid $300,000 for a house during the boom. That house is now worth $200,000, with a mortgage balance much higher than that. A city would seize the mortgage and pay the note holder $160,000. Gluckstern contends that would be fair-market value, after the potential costs of foreclosing on the mortgage are deducted.”

“The idea is not for the city to become a lender. Instead, he said, the homeowner would refinance his mortgage at $190,000, with help from Mortgage Resolution Partners. The extra $30,000 would be split between investors, local government and MRP, which would make a flat fee of $4,500 per transaction.”

A representative of the Securities Industry and Financial Markets Association called the above-described proposal a scheme for “short-term opportunistic investors to make a 20-to-30 percent profit” by “cherry pick(ing) the best loans out of a securitized poor and buying at a substantial discount.”

Prominent eminent domain attorney Gideon Kanner on his blog on Aug. 17 said, in reaction to the creative appraisal concept:

“Nobody seems to be asking why the awesome sovereign government power of eminent domain should be enlisted in quest of quick private profit…the public interest must predominate and the private benefit is limited to being incidental to it, as the court explained in [the case] County of Los Angeles vs. Anthony.” 

Kanner also asked what public interest is served in the above refinancing example when the loan in question is that of a performing mortgage where payments are being made.

Kanner also noted that, once the Pandora’s Box of eminent domain is opened up for underwater mortgages, the property owners could not be denied hiring their own attorney and appraiser and contesting any mortgage buyout or reduction offer.  If they won in front of a jury, the local government agency would be on the hook to pay court costs and the property owner’s litigation and appraisal fees.  This is minimally about $50,000 per case.

There is No Underwater Mortgage Free Lunch

The use of so-called “submerged eminent domain” has become a trendy cause by media elites Arianna Huffington and actor John Cusack.  However, no mention has been made that, in San Bernardino County, the proposal to use eminent domain would call for about 80 percent of all property owners to vote for higher property taxes to pay off the underwater mortgages of the other 20 percent of homeowners.

How long the concept of using eminent domain to reduce “underwater mortgages” would remain popular when all homeowners in a designated area would have to vote for higher property taxes remains to be seen.

By WAYNE LUSVARDI

California is getting strapped for cash to continue to pay for subsidies for economically infeasible solar power and energy efficiency projects for homeowners and small businesses.

So the Environmental Defense Fund has concocted a proposal to the California Public Utilities Commission called “On-Bill Repayment.” This program would have electricity users pay for such energy upgrades in their monthly electricity bills.  The upfront money for energy upgrades would come from loans through commercial banks instead of government subsidies.

On-Bill Repayment will not provide homeowners or businesses with significant costs savings but will provide green jobs.  The green marketing of On-Bill Repayment is so slick that even the naïve energy writer at Forbes magazine online has been duped by this proposal.

On-Bill Repayment will also provide banks with a source of loans that have no demonstrable benefit to borrowers. This is just what California does not need.  It would create yet another government financing bubble that, like subprime home purchase loans, would benefit banks and contractors but provide only inflated benefits to property owners.  On-Bill Repayment has the same markings as the housing bubble all over it.

Energy Loans Would Benefit Only Banks and Contractors

As for property owners — yippee!  They would get an expensive energy system with a useful life of maybe 20 years that produces power at maybe two to 10 times the cost of natural gas or hydropower. During the 20 years, the property owners will get no real energy cost savings. It is widely known that solar energy is not economically feasible without subsidies.  But the energy loans will run with the properties even if the properties are sold.

The only conceivable benefit would be to the property owner after 20 years when the loan is paid off.  But by then any solar panels would either be less efficient due to wear from weathering or technologically obsolescent due to newer technologies.

Once again, the only property owners they could stick with such boondoggle energy improvements and deadweight loans would be lower-income families who would likely be unknowledgeable about the touted energy benefits. Most commercial property owners would be too knowledgeable to have such loser improvements on their buildings.

And the banks wouldn’t want to hold such “loser loans” and would want to dump them into the secondary loan market.  Sound familiar?  This is what happened with “subprime mortgages.”

And once On-Line Repayment loanswere shifted to the secondary loan market, they would be prone to being “sliced and diced” as subprime loans were by Freddie Mac and Fannie Mae.  Once each loan was divided up among many secondary lenders — paradoxically called “securitization” — it would be nearly impossible to foreclose.

This is the situation we’re facing today with the secondary lenders holding billions of dollars of bad mortgages on their books that are dragging down the economy and government budgets at the same time.

Moral Hazards of Energy Bubble Loans

On-Bill Repayment programs will also create what are called “moral hazards” in economics.  It will provide a perverse incentive for energy contractors to inflate their calculations of energy savings.

And banks won’t be able to judge whether the energy savings are real or fabricated. But banks will also have a perverse incentive to make such loans, especially if government has quotas for energy loans– as it did for “anti-redlining” loans under the Community Reinvestment Act. So look for an “anti-greenlining” lending law to be floated by politicians if On-Bill Repayment programs are approved by the CPUC and California legislature.

Political Opportunism and AB 998

California State Sen. Kevin de Leon, D-Los Angeles, has already floated Assembly Bill 998 to authorize On-Bill Repayment financing for energy improvements. There will be a hearing on AB 998 on April 17 in the California Senate chambers.

De Leon is touting that AB 998 will create 20,000 jobs and save 7 million tons of C02 per year. But at whose ultimate expense when the loans go bad? It will be low-income property owners and local school districts that will ultimately suffer from such bubble financing of energy loans.

According to Wikipedia, de Leon has been a Spanish language teacher and an advocate for “more funding for low-income neighborhoods, more school construction, and health insurance for children.”  But there won’t be any cash for public schools or health care if we keep financing boondoggle real estate and green energy bubble loans.  But politicians only look at the short term of getting re-elected.

Apparently, we have learned nothing from the collapse of the national bank financing system in 2008. Opportunist legislators are still clamoring for bubble financing to create jobs and provide banks with loans that do nothing for property owners but stick them with a liability.  Green energy advocates have no conscience about proposing bubble financing for deadweight energy efficiency improvements. And banks will have to comply with probable new energy loan quotas to keep their banking charters in the state of California or face penalties for discrimination.

As we can plainly see with the proposal for On-Bill Repayment of green energy improvements, perverse incentives for “greed” start out as well intentioned and slickly marketed proposals by government and low income or green advocacy special interest groups, not with banks.  Banks will be prone to being corrupted but want to keep their bank charters. Banks will protect themselves against loss by secondary financing and slicing and dicing loans among many lenders to spread the ultimate losses.  But bubble financing for green energy will poison the banking system and ultimately state and local school district budgets.

Such is the state of civilization in California circa 2012 under the leadership of green Gov. Jerry Brown, who invented solar energy subsidies in the 1970’s.