Gov. Gavin Newsom wants the Legislature to agree to sweeping reforms in wildfire liability rules by July 12, before lawmakers start a one-month recess.

After first calling on legislative leaders to shape new policies to help investor-owned utilities deal with a hotter, drier, more fire-prone era in April, Newsom put forward his own plan last week. It’s most significant change is an end to the state’s unusual “inverse condemnation” law that requires utilities be held liable for damages if their equipment sparks wildfires whatever the circumstances. Like predecessor Jerry Brown, Newsom thinks a more reasonable rule is to allow utilities to escape liability if there is evidence that their equipment was properly maintained – a standard used in most other states.

Newsom says this rule and the establishment of a $21 billion fund to help cover the cost of future blazes – paid for equally by shareholders and ratepayers of Pacific Gas & Electric, Southern California Edison and San Diego Gas & Electric – would go a long way toward stabilizing the state’s power grid and helping PG&E out of bankruptcy.

Thanks to a quirk, ratepayers might not even notice their share of the tab. That’s because a $2.50 monthly surcharge first imposed on utilities’ customers in 2002 to deal with heavy costs from the 2000-2001 energy crisis that is supposed to end next year would be renewed through 2035 to pay ratepayers’ share of the wildfire fund.

Brown’s call for weaker liability rules was rejected

But Brown got nowhere with his call last year to end “inverse condemnation.” And Newsom will face the same obstacles – and a new one. That’s the fact that many lawmakers may be ambivalent at best about helping PG&E come out of the bankruptcy process it initiated in January over at least $30 billion in claims from harsh wildfires in Northern California in recent years. 

The reputation of the state’s largest utility has been in a free-fall since a 2010 gas pipeline explosion in San Bruno that killed eight people and led to PG&E’s conviction of six federal felonies for shoddy maintenance and interfering with federal investigators. 

Yet after the utility promised it would do a far better job in inspecting and maintaining gas transmission lines, in December, the California Public Utilities Commission revealed that it had found that PG&E managers pressured workers to falsify “tens of thousands” gas safety inspections from 2012-2017.

The revelations stunned CPUC President Michael Picker – leading him to suggest for the first time that PG&E be taken over by the state, be broken up into smaller parts or otherwise go through a radical overhaul. 

The view that PG&E status quo must end has been highly popular among Bay Area politicians, who cite the fact that Sacramento started up its own municipal utility nearly a century ago in response to poor, costly service from PG&E.

In May, San Francisco Mayor London Breed said the city was preparing a formal, multibillion-dollar offer for some of PG&E’s key assets. Breed said her city had a “unique opportunity” to bolster its “long-term interest.”

Help PG&E with bankruptcy? Or break it up?

State lawmakers from the Bay Area include some of PG&E’s most forceful critics, starting with Sen. Jerry Hill, D-San Mateo. Even before the revelation in December about PG&E’s years of falsifying gas inspection records, Hill had already called for the utility to be taken over by a public agency or coalition of agencies.

Hill and other lawmakers are unlikely to accept changes in “inverse condemnation” until PG&E is overhauled. One of the main reasons previous calls to change the rule have been opposed was because of concerns that letting up pressure on PG&E to meet safety standards would lead the utility to be reactive instead of proactive in maintaining its equipment.

Against this backdrop, Newsom’s push to get his fire relief plan approved by July 12 doesn’t appear realistic.

Gov. Gavin Newsom and his wildfire “strike force” surprised some with the vagueness of its most important recommendation: That it’s time to revise the “inverse condemnation” state law that holds energy utilities can be held fully responsible for fires that were caused by their equipment even if the equipment was properly maintained. The law appears to be an existential threat to Pacific Gas & Electric, the state’s largest investor-owned utility, which filed for bankruptcy protection in January after being blamed for fires that resulted in $30 billion in damages.

Newsom’s pointed deference to state lawmakers – saying he hoped they could hash out a plan by mid-July – is an example of the “leading from behind” management gambit, which has a mixed history. Just as the Obama administration did with aspects of its foreign policy, the Newsom administration is expecting its allies to take the helm. The governor said he believes progress is more likely with him in the background.

“I’m purposely not including my personal opinions because I actually want to accomplish something. And I believe it’s incumbent upon me to create the conditions where we can actually get something done, versus to assert a political frame,” Newsom told Capitol reporters.

The governor may also perceive political risk if he puts out his own specific blueprint for how PG&E, Southern California Edison and San Diego Gas & Electric can survive in a hot, dry era in which massive wildfires are common annual events.

Tactic seen as best for long-range causes

Leadership experts, however, think the “lead from behind” gambit works better for issues with low stakes or for long-term causes – for the most famous example, Nelson Mandela’s decades-long effort to end apartheid in South Africa – and isn’t necessarily right for addressing pressing problems.

Jack Dunigan, a longtime management consultant who runs The Practical Leader website, believes that “it works best in times and places of non-crisis. If a child is running into the street and into traffic, it is not the time to convene a focus group to discuss the threats of playing in the street. It is the time for action. Leading from behind, as [Harvard business professor Linda] Hill describes it, works best in non-threatening, non-urgent conditions.”

Given that PG&E emerged in 2004 after three years in bankruptcy and returned to regular operations, that may suggest that there is no urgent reason for Newsom to take a bolder approach. But the idea that the Legislature will be able to come up with a plan in three months or less is difficult to square with its recent history – and the intense dislike that many state lawmakers and Northern California residents have for scandal-scarred PG&E.

In January, after PG&E’s bankruptcy filing, state Sen. Bob Hertzberg told a Sacramento TV station, “Nobody in the Capitol wants to bail out PG&E, period, exclamation mark, end of story, full stop. They just don’t.”

While lawmakers don’t hold Southern California Edison and SDG&E in such contempt, any attempt to help them deal with wildfire liabilities that also protects PG&E would face tough sledding.

This background is why Newsom’s predecessor, Jerry Brown, got nowhere last year with his proposal to give state judges the flexibility to limit the amount of liability a utility has for wildfire damages based on circumstances – including consideration of the importance of a utility being able to continue to provide power to millions of customers.

Further complicating the prospects for relatively quick approval is that “inverse condemnation” is written into the California Constitution. Changing it would appear to require a vote of the public as well as two-thirds approval of both the state Assembly and Senate.

That could wipe out half the $30 billion in liabilities that the state’s largest power utility feared it faces because of brutal wildfires linked to its power lines and transmission facilities over the past three years.

PG&E’s stock went up 75 percent after the Cal Fire report on Thursday before slipping 16 percent on Friday.

Former CPUC leader: Bankruptcy a ploy to win bailout

The ruling was cited in a Los Angeles Times analysis that questioned whether PG&E really needed to go into bankruptcy on Tuesday, as it had previously announced it would. Former California Public Utilities Commission President Loretta Lynch told the newspaper that the utility had “created this crisis” as part of a corporate strategy to scare the state Legislature into approving a sweeping bailout to minimize disruptions for its 16 million customers.

Yet Lynn’s view was at odds with several recent developments. Credit rating agencies only continued to see PG&E as in near-deathbed condition and last week, S&P Global Ratings downgraded the state’s other two investor-owned utilities – Southern California Edison Co. and San Diego Gas & Electric Co.

S&P said PG&E’s travails showed the risks that California utilities face because of “inverse condemnation” – a state law which says utilities are financially liable for damages from fires caused by their equipment even if the utilities had not been found negligent.

Meanwhile, PG&E’s contentious relationship with the federal judge overseeing its probation stemming from its six felony convictions in the 2010 natural gas pipeline disaster that killed eight people in San Bruno (pictured) took a sharp turn for the worse. There is relatively little precedent for federal judges to play such oversight roles in complex cases. This had led to speculation that San Francisco-based U.S. District Judge William Alsup might be cautious in drawing conclusions after announcing in late November that he was reviewing PG&E’s role in recent wildfires in Northern California. Alsup was seen as lacking the background and experience of agencies like the CPUC and Cal Fire to evaluate the utility’s claims and evidence from wildfire sites.

Instead, the judge has already issued a preliminary ruling directly asserting that PG&E’s failure to properly insulate power conductors contributed to fire disasters in Northern California over the last two years, including the November blaze in Butte County that killed at least 85 people. A hearing is scheduled in Alsup’s courtroom Wednesday on his ruling, which could lead to the judge ordering PG&E to broadly upgrade its transmission equipment.

PG&E: Rates could go up five-fold

The San Francisco Chronicle reported last week that PG&E officials believed that compliance with a far-reaching Alsup order “could cost between $75 billion and $150 billion, requiring a one-year rate hike – at the low end of the spectrum – of more than five times current rates in typical bills.”

In its formal response to Alsup’s tentative ruling, PG&E indirectly questioned his expertise. The utility wrote that it is “committed to working aggressively and expeditiously with state and federal officials on system maintenance and upgrades and on wildfire mitigation efforts.”

“But the path forward to mitigating wildfire risk is best designed not through probation conditions, but rather through careful coordination with state and federal regulators, after appropriate consultation with other interested parties, based on the best science and engineering advice, with policy analysis that accounts for the full range of important but often conflicting social goals,” PG&E concluded.

State Sen. Jerry Hill, D-San Mateo, told the Bay Area News Group that he welcomed Alsup’s actions.

“A federal judge is actually saying things and hopefully will do something about the lack of maintenance at PG&E,” he said. “No one else has required that.”

Hill, whose district includes San Bruno, has long ripped the state Public Utilities Commission for what he sees as lax oversight of PG&E.

By Wayne Lusvardi

What a ripoff. San Bernardino County wants to use eminent domain to let a private mortgage lender cherry pick “underwater” mortgages without paying damages to the lenders. Doing so supposedly would stimulate the resale market for homes.

The county’s policy would socialize the losses and privatize the gains of the underwater mortgages.  This would be done by acquiring underwater mortgages by eminent domain and re-selling them in the mortgage market for a discount.  Essentially, all taxpayers in the county pay would pay off the difference between the full acquisition price and the re-sell price through a municipal bond. The private mortgage company working for the county would make a fee from each sale.

Phil Angelides Previously Headed Mortgage Company

Mortgage Resolution Partners is the mortgage company selected by San Bernardino County to resell underwater home mortgages.  This company was recently headed by Democrat Phil Angelides, the former state treasurer lost a bid for governor in 2006. Angelides also was the chairman of the national Financial Crisis Inquiry Commission that mainly blamed banks, not government, for the 2007-09 economic crisis.

Angelides was also the co-developer of a residential subdivision called Laguna West in Elk Grove outside of Sacramento. Trulia.com reports there are 24 foreclosures and pre-foreclosures for re-sale in Laguna West today.

I’m no lawyer. But as an eminent domain appraiser for over 20 years, I would find the county’s proposal to condemn only “underwater mortgages” where the homeowner is still making payments as a likely violation of the legal rules for appraising just compensation in California.

The Entire Loan Portfolio Needs to be Valued

The mortgages to be acquired by eminent domain would have to be valued by appraisers for their “Fair Market Value.”  What would be appraised would not be the physical, tangible real estate of each home.  What would be appraised would be the intangible value of the underwater mortgages. An underwater mortgage is where the unpaid portion of the loan on the property exceeds the current open market value of the home.

The loans would have to be acquired for their remaining loan balance in order to make the lenders whole. Mortgage brokers or experts, not real estate appraisers, would subsequently be asked to value the mortgages for re-sale.  The mortgages would be valued not on the basis of the “comparable sales price” of actual homes, but the discount rate paid by mortgage brokers in the mortgage market.

According to securities expert and commercial real estate appraiser Steve Body of Eagle Rock, the discount is likely to be in the 50 to 60 percent range. This discount would have to be paid for by all county property taxpayers through a bond. Only the intangible loan value of the mortgages would be taken, not the physical real estate of each home with an underwater mortgage.

To comply with accepted “before and after” valuation methodology under eminent domain law in California, a condemning agency must retain an independent appraiser to value the “larger parcel” of the property to be taken.

For example, an agency may only want to acquire the farmer’s field. This is what is called a “part taking.”  But what has to be valued is the entire farm, including farm buildings, water wells, water rights, crops in place, chattels, any vertically integrated “ongoing” businesses, etc.

The same rule would likely apply in San Bernardino’s situation.  The “underwater” mortgages are part of a larger portfolio of loans.  Whole loan portfolios are valued in the private sector by discounting the cash flow from loan payments to their present value.  Loan portfolios likely have a mix of loans that are “not performing” (loan payments are in arrears) and loans that are “performing” (owner is current on payments).

As I understand it, what San Bernardino wants to do is cherry pick the best performing loans and leave the lenders with the loans that have been given Notices of Default and are in the process of foreclosure.  In short, they want to cherry pick the top of competitive lenders mortgage portfolios — all in the name of the “public interest.”

As many legal experts have stated, there is likely no doubt that the county has the right to define what is in the “public interest.”  The county can likely establish that it can take mortgages and allow a private lender to make a profit on them by reselling them.  This would be like taking someone’s home and allowing a private developer to upzone the land and make a profit on the higher use of the property for redevelopment.

But the county would have to re-write the Code of Civil Procedure and case law in California if it thinks it just wants to value those mortgages that are underwater and not the entire loan portfolio of the lenders.  This would be a gargantuan task because the county would have to appraise the entire loan portfolio of every lender, not just the 5,000 underwater mortgages it plans to take. We’re talking about countless thousands of loans valued as of a specific date. And the holders of the loans would have to be tracked down and identified, which may be an impossible task.

Severance Damages Also Need to Be Valued

Even if the entire loan portfolio could be valued, any “severance damages” to the remainder of the loans would also have to be appraised. The intent of just compensation is to “make the property owner whole,” not only for the property taken but also for any damages.

To use a farm example again, any damages to the remainder of farmland would have to also be appraised in addition to the value of the land taken.

As commenter Michael Baldridge appropriately wrote in the Wall Street Journal online:

“They want to seize the note. The note is worth what the note says. It’s the underlying collateral that is worth less. If they want to ‘seize’ the mortgage, they’ll have to pay the owner market value of the note, which is whatever is left on the mortgage. The underlying collateral is irrelevant. Using Mortgage Resolution Partner’s logic, the government could seize the note on a new car the second it drove off the lot, and the car is now worth 10% less. Then sell the car back to the owner for a 10% lower price (and lower payments), taking all the future payments while sticking the car dealer with the loss.” 

If the county cherry picked the best loans, then it would have to pay any damages to the remainder of the lender’s loan portfolio.

According to Body, if the county’s action results in leaving a greater proportion of non-performing mortgages in the lender’s loan portfolio, this would likely alter the portfolio to a status of “junk” (B-minus or lower credit rating).  The overall loan-to-value ratio, the percentage of under-performing loans, and the default rate would also have to be considered.

Uneconomic Remnant

If the remainder of a lender’s loan portfolio became unmarketable or worthless due to the county’s actions, the remainder of the portfolio could be deemed an “uneconomic remnant.” 

The term uneconomic remnant means: “a parcel of real property in which the owner is left with an interest after the partial acquisition of the owner’s property”; and which the government agency “has determined has little or no value or utility to the owner.”

In such an event — where the portfolio remainder has no value — the county could be legally compelled to acquire the whole portfolio.

Inverse Condemnation?

There are many other flaws in the notion to use eminent domain to acquire underwater mortgages to re-stimulate the housing market in San Bernardino.  Another of them is that such an effort is likely to impair the market value of properties for sale with no mortgages on them — where the homes are owned “free and clear” of any mortgage.  Bailing out the figurative water from “underwater” mortgages would flood the market with too much of a supply of homes, resulting in a decline in value.  Fire-sale prices would likely result as the pent up demand to sell previously over-mortgaged homes would flood the market and depress prices further.  The value of non-mortgaged homes would likely be dragged down along with the value of previously over-mortgaged homes.

This could give rise to what is called an “inverse condemnation” or “regulatory taking” lawsuit, where the property owner sues the government for a loss in value.

Fatal Flaw in County Proposal

Having to pay “severance damages” could be a fatal flaw that would likely make San Bernardino County’s proposal to acquire “underwater mortgages” economically infeasible and politically unacceptable.

If damages also had to be paid, the private loan reseller for the county would be unlikely to be able to make a profit.  Another option would be to have all property taxpayers in the county additionally pay for any damages to the remainder of the lender’s loan portfolio, as well as the underwater mortgages. Taxpayers might be outraged to have to pay damages as well as having to pay for what constitutes a gift to homeowners with underwater mortgages.

And if any homeowners file an additional lawsuit for “inverse condemnation” damages for impairing the market value and marketability of their homes, this could result in the county having to pay double damages to both the mortgage lender and third-party homeowners who couldn’t sell their homes.

San Bernardino County would be wise to ask the office of Attorney General Kamala Harris to issue a preliminary ruling of whether such a use of eminent domain is legal. And if so, the attorney general’s office should indicate whether the county would have to comply with the State Eminent Domain Code and the State Rule of Appraising Partial Acquisitions of property.

Advice also should be asked of eminent domain legal experts such as Gideon Kanner.

With San Bernardino city just declaring bankruptcy, and even faces a criminal probe, San Bernardino county shouldn’t compound the area’s economic problems.