A plan to use eminent domain to seize underwater mortgages has raised hopes of homeowner bailouts in cities stricken by the housing crisis, including Sacramento, Rancho Cordova and Elk Grove.
But would such a novel plan even be legal?
Experts say the proposal being shopped around by San Francisco's Mortgage Resolution Partners may well meet the U.S. Supreme Court's broad definition of a public use under eminent domain law. The investor group is encouraging cities and counties to condemn mortgages and cut the amount borrowers owe to prevent blight and boost local economies.
The sticking point, legal experts say, will be when it comes to paying the "just compensation" required under the U.S. and California constitutions.
"My guess is the courts will uphold the constitutionality of this, but it will be messy," said Steven J. Eagle, an expert in government takings at the George Mason University School of Law in Arlington, Va.
Mortgage Resolution Partners formed at the start of the year to promote a plan it said would both bolster the housing market and turn a profit for its investors. Its first chairman was developer and ex-state Treasurer Phil Angelides, who later resigned. Its half-dozen partners include financiers and Silicon Valley executives. The group counts former state Assembly Speaker Willie Brown among its investors.
Current Chairman Steven Gluckstern, a venture capitalist and one-time owner of the New York Islanders hockey team, has been talking to cities and counties around the country, advocating his plan. San Bernardino County already has formed a joint powers authority with the cities of Fontana and Ontario to consider the proposal. Chicago leaders held a hearing on it this week.
Leaders in the Sacramento region â" including Elk Grove City Council members, the Rancho Cordova city manager and advisers to Sacramento Mayor Kevin Johnson â" have met with MRP representatives and are mulling their options.
"If we can do something collectively, it would make more sense," said Cassandra Jennings, a senior aide to Johnson.
Mortgage Resolution Partners is proposing that local governments seize the mortgages of homeowners who are underwater but current on their payments, and whose loans are held by private investment trusts. About one in 10 mortgages in Sacramento County would qualify. To turn a profit, the plan relies on governments paying less than the current market value of the homes that secure them.
Gluckstern contends that the notes are worth less than the value of the houses because owners are more likely to default if they owe more than their homes are worth. The purchase price should be discounted by the potential costs of foreclosure, he told The Bee in a recent interview.
For investors who own mortgage-backed securities, that would mean losing the best loans from the bundle of mortgages that generate their investment income.
Meanwhile, MRP and its investors, who would front the money to local governments to buy the loans, stand to reap big returns. The plan calls for homeowners to refinance for more than the governments paid for the mortgages. Investors would take a share of the higher refinance amounts. And MRP would make a $4,500 fee per transaction. The fees and profits could add up to tens of millions of dollars in Sacramento County alone.
MRP's plan is a strategy for "opportunistic investors to make a 20 to 30 percent profit" by "cherry pick(ing) the best loans out of a securitized pool and buying at a substantial discount," said Timothy Cameron, an executive with the Securities Industry and Financial Markets Association, which represents the mortgage-backed securities sector.
The group has distributed legal memos challenging the plan.
Lawyers and law professors who specialize in eminent domain law questioned the assumption that the loans Mortgage Resolution Partners proposes acquiring can be taken fairly at a discounted rate. They say that part of the proposal could result in hard-fought legal battles over valuation.
"There's going to be a lot of pushback," Eagle said. "Determining what just compensation is will be very difficult."
Making it more difficult is the fact that Mortgage Resolution Partners proposes taking only underwater mortgages for which borrowers are current on their payments. Gluckstern said those loans have the best chance of being refinanced and helping the plan succeed.
But the attempt to "pluck low-hanging fruit" at a steep discount might not fly with the courts, said Gideon Kanner, a professor emeritus at Loyola Law School in Los Angeles who specializes in eminent domain law. And it will be up to the courts to decide what the loans are worth.
"A mortgage on which payments continue to be made is going to be worth a lot more than a mortgage where an owner has defaulted," Kanner said.
Lawyers for the Securities Industry and Financial Markets Association are challenging the proposal on constitutional grounds, arguing that it violates the Fifth Amendment's takings clause, which allows eminent domain only for public use and only with just compensation.
However, outside experts, including several who expressed skepticism about the plan, said they doubted the opponents' constitutional arguments would hold up under current case law.
The U.S. Supreme Court has allowed cities to seize many forms of property, including land to build roads and schools, intangible assets such as securities, and commodities such as hundreds of tons of black pepper during World War II.
"You can condemn patents, copyrights, contracts," Kanner said. "It doesn't have to be land."
And judges have granted lots of leeway to governments to decide which takings qualify as public uses, including those in which property is immediately handed over to other private parties.
In the 2005 case of Kelo v. City of New London, for example, the high court let the Connecticut city condemn residents' homes so that the land could be transferred to private firms for redevelopment. The promised economic benefits, which never materialized, constituted a public use, the justices said.
Kanner said he could envision the issue rising to the level of the U.S. Supreme Court if the justices wanted to pull back from their Kelo decision, which prompted a national backlash.
"A case like this comes along, and it will be an opportunity to retreat a tiny step and draw some kind of line on eminent domain," he said. "The Supreme Court could say, 'You've gone too far.' "
Call The Bee's Hudson Sangree, (916) 321-1191.
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