By Wayne Lusvardi

When did the California Dream begin?

Peter Huck, a refugee journalist from Los Angeles to New Zealand, has an answer. He writes in the July 20 issue of the New Zealand Herald newspaper “Sustainability Reinventing California Dream” that the California Dream began when Los Angeles Department of Water and Power’s William Mulholland said at the 1913 opening of the California Aqueduct: “There it is, take it.”

Huck believes that “sustainability” will lead to an economic recovery in California.

But the California Dream may have ended with California’s Anti-Sprawl Law, Senate Bill 375, which Huck champions in his article as an economic stimulus to get the state out of a managed depression.

More recently, the County of San Bernardino in California has proposed to use eminent domain to condemn mortgages on “over-mortgaged” homes.  The county would do this by spreading about 30,000 over-mortgaged loans to all 699,000-property owners in the county by way of additional property taxes.

If there is a new slogan for California nearly 100 years after Mulholland’s epic statement, it is: “Socialize losses and privatize gains.”  Which is another way of saying: “Everyone wants out of bubble-created debts, but no one wants to pay for them except through more bubbles.”

Yet no one in San Bernardino has apparently realized that reducing the over-mortgaged portion of home loans will just lower assessed property values and drastically reduce property tax revenues.  Mass delusion is starting to spread across desperate California just as the Tulip Bulb Mania, the South Seas Bubble and the Mississippi Bubble followed the debt bubbles of the 1700’s in Europe and early America.

“Sustainable” Transit Will Result in Unsustainable Water

Having handled land use for a regional water agency in California for 20 years, I find that Huck has focused on the ideological level of explanation, rather than the empirical.

Contrary to Huck, steering population and housing into coastal cities in California will result in an unsustainable use of water resources.  Infill housing near urban job centers may result in fewer auto emissions from auto commuting.  But diverting population growth to dense urban cities will also force greater reliance on imported water supplies from the Sacramento Delta and the Colorado River.  California’s cities depend on groundwater for about one third of their water during dry years.

What has historically made water valuable in California has been the relative cheapness of water from urban groundwater basins compared to expensive imported water.

The anti-sprawl law will require that cities adopt sustainable growth plans to shift new development from the urban fringe, where groundwater resources are more abundant, to highly dense urban areas, where local water supplies are patchy and often polluted from war time industrial toxic wastes.  It would take decades, if ever, to clean up polluted urban groundwater basins.

Viewing a map of groundwater basins and a map of housing density for California indicates that water and populations are not geographically proximate. The densest populated areas are mostly along the coast while most groundwater resources are inland.

Moreover, by virtue of shifting to reliance on imported water supplies, California will need to buy more imported electricity to pump that water to urban centers located far from the sources of water.  Will expensive Green Power mostly be used to pump water long distances?  Or will Green Power be dedicated to powering the proposed California High-Speed Rail Authority?

Solar power can only be used in mid-to-late daytime; while wind power mostly peaks at night.  But neither can be relied on for non-peak load power uses — homes, industries, hospitals, and public transit — because they are unreliable and thus unsustainable.

How Cal Energy Crisis Resulted in “Sustained” Drought

In 2001, this writer was a member of an Energy Crisis Task Force for a large regional government water utility.  The original cause of the California Energy Crisis of 2001 was the 1996 Federal Environmental Protection Agency “mandate” to California to clean up urban smog by 2001 or face a cut off of highway and education funds.

The only way to comply with the federal mandate was to shut down old polluting fossil-fuel power plants along the California coast owned by Pacific Gas & Electric, San Diego Gas & Electric, and Southern California Edison companies.  Then these obsolescent power plants had to be divested to private operators and converted to cleaner natural gas fuel power plants.

California was not running out of energy in 2001; it was running out of clear sky.  The real crisis was not energy, but how to pay off the old stranded or “underwater” mortgages — called corporate bonds — on the mothballed power plants. Everybody wanted smog eliminated, but no one wanted to pay for it.  Federal environmental policy became “clean air at any cost.”

The initial energy crisis solution in 2001 was to give a quasi-monopoly to natural gas suppliers, mainly in Texas, to try to pay off the bonds on the old power plants. This policy was erroneously called “deregulation,” which failed. The plug was pulled on deregulation by the Democratic legislature and governor and replaced with a system of energy price caps.

Retail electricity prices were eventually capped; but wholesale energy prices were not resulting in an induced energy pricing fever. This bubble in energy prices was intentionally created to pay off the unpaid mortgages on the mothballed power plants.  But it also failed miserably and even resulted in some fatalities.

Finally, some $42 billion in mortgages were paid off by energy price premiums loaded into long-term energy contracts mainly to run the pumps for the California State Water Project.  Smog reduction was paid for by inflated water rates.

By 2007, a man-made drought resulted from an environmental lawsuit to protect the purportedly endangered Delta Smelt fish in the Sacramento Delta. In 2010, an appeals court ruled that the allegation that the Smelt was endangered was bogus.

By manufacturing a drought, California not only protected a bubble in water rates that securitized the pay off of long-term bonds to reduce smog, but also brought about even higher water rates. These higher local water rates have not been repealed anywhere in California after the court-ordered drought was ended in 2010.

California Politician’s Dream Come True: “Taxation without Representation and Limitation”

Loading the cost to clean up the air into water contracts avoided having to go to the California Public Utilities Commission for an electric rate increase, to the Legislature for a tax increase, or to the voters for the approval of a tax increase, as required under Proposition 13.  To politicians, it was a California Dream come true: ”taxation without representation and limitation.” But it led to economic stagnation.

Long-term water contracts expire in 2013, when AB 32, the California Global Warming Solutions Act of 2006, kicks in.  In other words, in 2013 California will no longer pay premiums loaded into the price of water to pay off the cost to reduce smog.

But a replacement premium will be added to electricity rates to pay for the mandatory shift to expensive Green Power.  Solar and wind power located in remote areas is supposed to reduce urban air pollution but will add transmission costs.

This will prevent the building of new conventional power plants in urban areas where smog is trapped in urban air basins.  It isn’t solely pollutants that cause smog, but the trapping of pollutants in air basins.  The solution to pollution is dilution and dispersion — not anti-sprawl legislation that will concentrate more people in dense urban air basins who will travel to work in bullet trains subsidized by Cap and Trade taxes disguised as a pollution emissions market.

Moreover, back up conventional power plants will have to cycle up and down as the sun shines or clouds cover the sun and the wind gusts. Power-plant “cycling” will cause more air pollution as surely as pushing your gas pedal up and down constantly in your car or frequently moving your home thermostat will do the same.

The California Energy Crisis of 2001 ended up loading the huge cost to reduce smog into premiums in water rates.  That, in turn, resulted in the necessity of an artificial drought.  Instead of building more dams, reservoirs and pipelines, the only way left to manage water supplies was by conservation. California had to protect its water-rate bubble, and thus had to squelch any new water development or water markets for over a decade.  It needed a “sustainability” ideology to legitimate its conservation policy.  “Sustainability” is just public “hucksterism” if you will forgive the pun.

California may finally put an $11 billion water bond on the election ballot in 2014, coincidentally after the bonds on the California Energy Crisis of 2001 are paid off.

The Solution to Bubbles is Not More Bubbles

In Michael Lewis’ pop economics book, “Boomerang: Travels in the New Third World,” he describes the blowback from Greece’s debt-created bubble.  All Greeks wanted the national debt reduced, but nobody wanted to pay for it.

Greece tried to load its unpaid national debt into electric power rates.  This only resulted in ratepayers refusing to pay their electricity bills and falling revenues for the state utility agency.  The result was power blackouts, disinvestment by the bond market and social and political destabilization.  Should we expect anything less from California’s loading of the cost to reduce air pollution in water rates securitized by water conservation and legitimated by a “sustainability” ideology?

Contrary to Peter Huck, a “sustainability” ideology will not result in an economic recovery for California. The future of California’s economy is more likely to be slow growth due to having to pay down the private sector mortgage-debt bubble and the public sector’s pension, redevelopment and air quality-water rate bubbles.

Creating new tax bubbles by condemning “underwater” mortgages, by Cap and Trade “tax farming,” and by inflating Green Power rates, will only assure the older bubbles will be replaced with new ones.  California band musician Lawrence Welk famously invented “the Bubble Machine.” But perhaps comedian Stan Freberg was prophetically right when he recorded his spoof of the Lawrence Welk Show by saying it was time to “turn off the bubble machine?”

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.

By John Seiler

Our colleague Steven Greenhut has a column up on Bloomberg on as scam in San Bernardino County:

“Officials in San Bernardino County, California, believe they have figured out a clever way to solve the county’s, and possibly the nation’s, housing problems.

“Detailed by a Cornell University professor, and pitched by influential San Francisco investors who stand to make a fortune from it, this new idea is based on one of the oldest concepts: the taking of other people’s property.

“County officials, joined by the cities of Ontario and Fontana, are considering using an expansive interpretation of eminent domain — typically used to acquire real property to build public works — to seize the mortgages, not the real property, of those homeowners who owe more than their homes are worth.”

Read the rest here.

And Greenhut’s book on eminent domain, “Abuse of Power: How the Government Misuses Eminent Domain,” is available on Amazon.com.