Kanner’s recent analysis  — “Stop the BS About Underwater Mortgage Eminent Domain Takings” — on his website Gideon’s Trumpet tells a different story than what most of the public is reading in the mainstream media. Kanner calls most of the people writing on the subject “clueless” for several reasons.

What clueless media never explain

First of all, Kanner points out that the city of Richmond will have to pay just compensation to lenders — not some “bargain basement figure pulled out of thin air” so that the city and its mortgage carpetbaggers can reap a windfall.  And this compensation has to be deposited in full at the start of the eminent domain action.  Citing Article 1, Section 19 of the California Constitution, Kanner says: “the ‘just compensation’ called for in the state constitution has to be ‘first paid’ – in full, and up front, that is – before any taking can occur.”  Apparently, cash-strapped Richmond is going to borrow the money from its mortgage advisors to make this upfront payment.  This means the city will have to go into more debt.

As pointed out by me elsewhere, this will mean the city will have to pay back its mortgage consultants’ investors instead of the investors of the banks that hold the mortgages.  Whether the courts would allow mortgage lenders to be stiffed to enrich mortgage consultants working for cities is doubtful.

Secondly, Kanner says Richmond will have to pay “fair market value” which is defined as the “highest price” and not some bargain price coerced from a seller under duress of the eminent domain law.  In other words, Richmond and its mortgage partners cannot pay a low-ball price to make a profit for themselves on the backs of lenders.

Kanner says that if Richmond’s “harebrained scheme becomes a’cropper, as it likely will, for one reason or another, it won’t be the first time Richmond got its greedy finger burned playing with eminent domain.”  Kanner cites the 1977 case of Richmond Elks Hall versus the City of Richmond Redevelopment Agency (561 F. 2d 1327 – 9th Circuit).  This case is one of the leading cases of eminent domain abuse in the state wherein the courts ruled against a city trying to pick up properties on the cheap.  The court rejected Richmond’s low-ball compensation in that case.

Eminent domain arbitrage: buy low, sell high

According to the compensation formula reported by the city’s mortgage advisors, the city can only make mortgage eminent domain work by arbitraging –– buying the mortgages at the lowest price and then allowing its mortgage middlemen to sell them for the highest price.  Courts have historically rejected the tactic of cities trying to to downzone a property so it could be condemned on the cheap.  The same principle of banning municipal arbitraging would likely apply to the city of Richmond.

Richmond would also have to pay damages to lenders for any losses to their whole loan portfolio.  Kanner says that Richmond’s scheme to take only mortgages where the homeowners are making payments would leave lenders with only bad mortgages that are in foreclosure.  Thus, Richmond would likely have to pay damages.  In my experience as an appraiser for a large public utility, sometimes damages can exceed the whole value of the property.

Richmond will also have to pay its own attorney fees.  And if the city loses each court case, it will have to pay the lenders’ attorney fees.  It typically costs a minimum of $50,000 for legal representation in eminent domain cases. Damages and attorney fees alone could eat up all the profit that Richmond and its mortgage consultants expect to make.

Where is the condemnation of condemnation?

Kanner views the upcoming eminent domain trials as “spectator sport” brought about by harebrained academics, greedy mortgage consultants, “big shot lawyers” who are ignorant about eminent domain law, and cash-strapped cities who hope to plug holes in their pension plans with ill-gotten gains from eminent domain.  The city of Richmond thinks it would reap $48 million under this scheme. To imagine what Richmond is doing imagine the city of Bell in Los Angeles County using eminent domain to fund fat-cat salaries, perks and benefit plans for the City Council and its cronies.

Mortgage eminent domain in Richmond is likely to backfire in a big way.  Are elected leaders in Richmond prepared for recall elections when all this backfires on them?  Stay tuned.

By Steven Greenhut

SACRAMENTO — First, Vallejo, in 2008. Next, Stockton, then Mammoth Lakes and, now, San Bernardino and soon, perhaps, Compton. As Orange County Supervisor John Moorlach told Bloomberg News, the bankruptcy dominoes are starting to fall. One California city after another – following a decade-long spree of ramping up public-employee pay and pension benefits, as well as redevelopment debt – are becoming insolvent.

And the state’s legislators have nothing constructive to offer.

California’s exclusively Democratic leaders not only are unwilling to rein in the costs of benefits for their patrons, the public-sector unions, they have been erecting roadblocks in the paths of localities that want to fix the problem on their own. Yet all the political hurdles in the world cannot fix the basic problem of insolvency.

Stockton navigated the new process created by a state law requiring a 60-day period of negotiations before a municipality could file for Chapter 9 bankruptcy.

That period is over, and the city – a hard-pressed port on the edge of the California Delta – has become the largest city in the country to pursue municipal bankruptcy. The cause was a pension system eating up 30 percent of the budget, an absurdly generous retiree medical program and excess bond debt for pension obligations and redevelopment projects.

Soon after, Mammoth Lakes decided to pursue bankruptcy. That city’s cash crunch resulted from losing a lawsuit over development. Although not tied to public-employee compensation, the situation was caused by city officials who preferred to play developer rather than tend to the nuts-and-bolts duties of city government – a long-term problem in that eastern Sierra vacation town. In 1996, Mammoth Lakes lost a court case after it declared its downtown area blighted because of excess urbanization, in a ruling the judge said exemplified the misuse of redevelopment power.

San Berdoo bankrupt

The latest city to opt for bankruptcy is San Bernardino, which has declared a fiscal emergency. That step allows it to evade the mediation period mandated by state law. The city simply doesn’t have the cash to keep operating. As Bloomberg reported, “San Bernardino and its agencies have more than $220 million of debt, including $48.6 million of taxable pension-obligation bonds, according to financial statements.” Pension-obligation bonds are used by cities to pay ongoing pension expenses, yet San Bernardino’s problems show that a city cannot borrow its way out of debt.

Other big cities, including Los Angeles, are talking more openly about the bankruptcy option. Not long ago critics who mentioned the B-word were considered Chicken Littles.

A current talking point is that these cities couldn’t control what happened to them. The Riverside Press-Enterprise reported: “The city of San Bernardino’s financial woes are a direct correlation to a torrent of foreclosures in the Inland area of Southern California, the national foreclosure tracking firm RealtyTrac said Thursday. ‘Property taxes plunged in San Bernardino because of an avalanche of foreclosure activity during the recent housing bust,’ said RealtyTrac vice president Daren Blomquist.”

Housing Bubble

There’s no doubt San Bernardino and Stockton – ground zero for the subprime mortgage crisis – suffered from the problem described above. But, during the housing bubble that built for years before the crash, what did those cities do with the resulting surge in property tax revenue? We know – they squandered it on increased compensation for government employees, on redevelopment projects and other questionable spending. They squandered a windfall and now depict themselves as victims of circumstance.

The real culprit is foolish decision-making. Stockton, for instance, refused to take advantage of an exemption in prevailing-wage laws – a strategy that could have saved it money but would have angered the powerful unions.

The housing bubble hit the hardest in cities inland from the growth-controlled major metropolitan areas. When housing prices went up in Los Angeles and San Francisco, developers moved inland, where it was easier to get the permits necessary to respond to the demands of the marketplace.

Coastal cities

But even coastal cities are struggling. Los Angeles is not a victim of the foreclosure crisis. Pension costs in San Jose – where the housing market has rebounded thanks to a healthy tech-based economy – rose 350 percent in 10 years and now consume 20 percent of the general-fund budget. San Jose voters approved a pension reform measure last month to stem the fiscal bleeding.

Joe Mathews, writing for the Prop Zero blog, debunks San Bernardino leaders’ allegations blaming the state for the city’s its fiscal problems: “Local elected officials who complain about a lack of state money have things backwards. The state of California is relatively spare in its spending, compared to national averages. California’s local officials are, by contrast, big spenders, at or near the national lead in compensation for local workers, especially law enforcement.”

Mathews misses a big point – California state government spends its money poorly – but he is right about local-government wastrels, who busted the bank on public-safety pay and benefit packages and now are looking to cast blame anywhere they can.

Bankruptcy is not a great option but, at least, it gives cities a chance to get their house in order and start fresh. Unfortunately, Vallejo and Stockton refused to tackle existing pension debt in their bankruptcy reorganization plans. Orange County emerged from bankruptcy in the 1990s in better shape than ever, but, as writer Chris Reed explained on the website Calwatchdog.com, subsequent boards of supervisors then began spending like crazy on public-sector compensation.

Bankruptcy cannot stop future officials from wasting tax dollars. But when there’s no money, there’s nothing left to do. In Scranton, Pa., a judge issued an injunction to stop the mayor’s plan to begin paying all city employees minimum wage. But there’s no money left to pay any more than that, the mayor said. The city gladly will pay more as soon as it has the cash.

Only when the money runs out will cities find the necessary solutions.

That’s perhaps the saddest commentary on the situation in California cities these days.