By Mark Cabaniss

Caught between rising pension costs and  declining tax receipts, several local governments in California have gone bankrupt, including the city of San Bernardino, which has stopped making its required contributions to the California Public Employees Retirement System.  CalPERS is threatening to sue.

Meanwhile, the county of San Bernardino is thinking of trying to help the local economy by injecting it with billions of dollars, which, unfortunately, it doesn’t have.  So the people who run the county are thinking of simply seizing the money by using eminent domain.  But an examination of the plan reveals a simple scheme in which the right hand of government robs the left hand of government, because the idea that has been floated is simply to confiscate the money from institutional investors — and many of these institutional investors are pension funds, including government pension funds like CalPERS.

The plan came from Mortgage Resolution Partners, or MRP, of San Francisco, and it goes like this:   local governments would try to help local homeowners out of the housing crash by using eminent domain to condemn underwater mortgages, then refinance the mortgages with lower principal amounts, which would then have lower monthly payments, so local homeowners wouldn’t have to take the losses from the bursting of the property bubble.

MRP would take a $4,500 fee for each refinanced home. As there are an estimated 20,000 to 30,000 homes in San Bernardino County that would be good candidates for the plan, that would make MRP’s cut $90 to $135 million in San Bernardino County alone.  And the plan might expand elsewhere in California, even other states.

A public purpose supposedly would be served because each refinanced homeowner would suddenly have hundreds of dollars of “free money” each month to pump into the local economy.  But so far, there has been no mention of who would lose all of this free money, other than some vague references to “Wall Street.”

Robbing Peter…

At first glance, this seems like a typical government plan to rob Peter to pay Paul; to give “free money” to local residents, which money has been taken from some guy, somewhere, “out there.”  However, the proposed mechanics of the plan make it doubtful that all of the negative effects from the confiscation could be foisted off onto some nebulous, nefarious rich Wall Street types in other states.

More likely, it’s going to be robbing Peter to pay Peter — one part of government robbing another part.

A good, and even mostly sympathetic, article explaining the plan was written by Ben Hallman for the Huffington Post. When banks make a home loan, they don’t keep all the mortgages.  Many of them are sold off to other investors, in pools, to mitigate the effect of individual defaults.

These pooled mortgages that are sold off are of two types: agency debt and non-agency debt.  Agency debt refers to mortgage debt that is guaranteed by the federal government through one of its agencies, such as Fannie Mae and Freddie Mac.  These government-owned home loans comprise the largest pool of underwater mortgages across the country, estimated at 3.3 million, but these loans would not be included in the MRP plan.  Instead, the plan would confiscate, through condemnation, only privately-owned, non-agency debt. Hallman explained:

“Private investors, including pension funds like California Public Employees’ Retirement System and the giant bond fund Pacific Investment Management Co., own much of the rest of the outstanding mortgage debt, which adds up to about 10 percent of all loans.

“These mortgages, though small in number, are most likely to be deeply underwater, and thus are in the most danger of failing. Privately owned loans are three times as likely as Fannie Mae or Freddie Mac loans to be underwater, for example. [Chief Strategy Officer John] Vlahoplus of Mortgage Resolution Partners said the eminent domain proposal is designed to target exactly these privately held mortgages that are at the highest risk of foreclosure.”

So the plan is to specifically target and seize CalPERS and other pension funds’ assets and give them away to lucky underwater homeowners — minus MRP’s cut, of course.  At bottom, this is a scheme for government to rob government pension funds, among other funds, to get the money to bail out underwater housing.

Fighting back

Some Securities Industry and Financial Markets Association members, perhaps mindful of their fiduciary duty to investors to protect the investments that are supposed to secure their retirements, began discussing ways to fight back when the confiscation plan was first floated.

But California’s irony-free Lt. Gov. Gavin Newsom wrote a letter to Attorney General Eric Holder demanding criminal prosecution of the targeted victims, who had been talking to each other about possible responses, as having violated the antitrust laws.

Newsom hasn’t had to write a letter demanding the prosecution of anyone at CalPERS — yet.  And he hasn’t had to write a letter demanding the prosecution of anyone at the Retired Peace Officers Association of California, or the California Judges Association — yet.

But CalPERS had a dismal rate of return of only 1 percent in 2011, despite having an assumed rate of return of 7.75 percent at the time (since reduced slightly to 7.5 percent), which was used in all their calculations projecting that their fund is solvent.  And California taxpayers and California government retirees are increasingly at odds about who should pay how much for a system that is increasingly seen as wildly unsustainable.

So, a few questions: What if CalPERS does become insolvent?  And what if the taxpayers are simply too broke to bail out an insolvent CalPERS?  Against that looming backdrop, shouldn’t CalPERS’ leadership at least try to protect their fund assets from naked confiscation? Shouldn’t they say something?  A peep?

So far, CalPERS is like Sherlock Holmes’ dog that hasn’t barked, leading one to wonder whether being backstopped by the taxpayers for investment losses has anything to do with their silence, even while a looting party is forming to come after their retirees’ assets. It is probably just a question of time until the CalPERS retirees realize they are in the crosshairs of a plan to forcibly seize their retirement assets.

When that happens, and the politicians realize they have to face down retired cops and firefighters rather than faceless Wall Streeters, perhaps this ridiculous plan to use government to confiscate the private property of some people and give it to other people will be laughed off the public stage.

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.