It was Tuesday night, Setpember 10th, 2013. Hundreds of people had gathered in an auditorium in the small California city of Richmond, CA in the East Bay to endure a City Council meeting.
Before the Richmond City Council was a simple proposal to continue a process unanimously approved back in April. But to Wall Street's Eye, it was as if Frodo were standing before the Cracks of Doom, about to toss the One Ring into the fire.
One of the opposition Council members, commenting on the motion before the Council, rhetorically inquired
"We're a small city of 110,000 people. Do we really want to be taking on Wall Street?"
The vast majority of the audience responded with a
Hell Yeah!
Background.
Richmond, California has been hit as hard or harder by foreclosures than any municipality in the country. About half of the homeowners in Richmond are "underwater," their homes worth less than their mortgages. Foreclosures have contributed to a massive decline in property values, the blight of neighborhoods, and the loss of Richmond's tax base. If foreclosures could be reduced or all but eliminated it stands to reason Richmond would gain.
One of thousands of foreclosed homes in Richmond over these last four years
Richmond's municipal government has proposed to consider using eminent domain to buy out mortgages - for their fair market value - on houses in Richmond that are underwater, then turn around and issue new mortgages with a reduced principal balance to those homeowners.
This idea has shaken Wall Street from its foundations to its proud and bitter crown. It is threatening to cut off all mortgage financing to the city (i.e., redline Richmond). Banks have threatened to sue the city back into the stone age (or at least, ironically, into bankruptcy). They have unleashed a host of demon lawyers and orcish publicists, all sounding the doom of the world as we know it should Richmond go through with its scheme. More absurdly, through their local minions, they even paid UC Berkeley fraternity peeps to attend the City Council meeting all wearing red shirts and sporting the positively newspeakish message "Don't let Wall St. Take Another Bite Out of Richmond Homes!" Uh, Huh?
What the Program Would Do.
Here's an example of what might happen if Richmond's proposal were implemented.
Suppose John and Mary Smith own a house on which the outstanding mortgage balance is $400,000. If the house were sold today, it's fair market value would be $200,000 (The real estate market has come back in many places, but barely at all in Richmond.)
Suppose someone offered to sell the Smith's mortgage to you (i.e., the right to the monthly payments and to foreclose if payments stopped). How much would you be willing to pay? I don't know how much I would pay; I'm no mortgage analyst. But the Smith's could stop paying at any time and ultimately walk away, leaving me stuck with a house that I could only sell for $200,000, netting a good deal less because of the sale commission, taxes owed, repairs, transfer fees and the like.
We know that Wall Street analysts have sophisticated computer programs running on state-of-the-art supercomputers which can accurately estimate how much any mortgage is worth given a set of known factors - the risk of default, neighborhood property values, whether the owners have a steady income, and so on.
Let's just say for the sake of argument that a rational investor would be satisfied paying $180,000 for the rights to the Smiths' mortgage. (For all I know it could be less than $150,000, or more than $200,000, but let's just go with this).
What Richmond wants to do is go to the mortgage holder and say, "Look, I know that if you offered this mortgage for sale on one of your fancy mortgage trading markets - you know, the ones that nearly crashed the entire world's economy - someone would be willing to pay you $180,000 for it. Here's $180,000. Give us the mortgage."
A rational mortgage holder would then say, "Well, I don't know. How about $190,000?" And then Richmond might say, "$185,000." And the current mortgage holder would say "Okay, done!"
Richmond, now the owner of this mortgage, would basically burn it, then turn around and give the Smiths a new mortgage with a principal amount of $200,000 (the current market value). They're no longer underwater, the monthly payment drops significantly, the chance of default has been massively reduced, the investor-owners of the previous mortgage have been fairly compensated, the Smiths might well spend the money they are saving on their mortgage payment at local shops, and everyone is happy.
But that's not how things are proceeding. Richmond has already approached mortgage holders of 624 underwater properties and they all said...
Crickets.
Not a peep. Not a reply. Not a counteroffer. Nothing. Except...
A lawsuit!
Indeed, Wells Fargo and Deusche Bank filed a lawsuit against the City of Richmond because they offered to buy some mortgages owned and/or serviced by those banks FOR THEIR FAIR MARKET VALUE!
Why?
The Use of Eminent Domain.
What happens after the current mortgage holders refuse to sell, as they just did. If a private entity wants to buy, but an owner refuses to sell, it's game over. But if it's a public entity that wants to buy, and an owner doesn't want to sell, then the public entity can invoke the eminent domain clause of the Fifth Amendment to the US Constitution to seize the thing in question and pay the previous owner its fair value.
No person ... shall be ... deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.
That's what Richmond is saying it might do (but has not done; nor even authorized doing yet; so far they've just talked about it as a possibility) should the banks refuse to sell. And that's what's causing Wall Street apoplexy.
Where is the "public use" in seizing privately held mortgages? How about neighborhood stability, preventing neighborhood blight, maintaining the tax base, keeping residents in their homes, fewer homeless on the streets, and a more robust local economy? The banks claim that it isn't really a public use. They claim this is strictly a boon for the property owner at the expense of mortgage investors and banks.
The problem they will run into with their eminent domain argument is a Supreme Court decision known as Kelo v City of New London.
In a 5-4 decision, the Court held that the general benefits a community enjoyed from economic growth qualified private redevelopment plans as a permissible "public use" under the Takings Clause of the Fifth Amendment.
In other words, if you own a house that owes $3000/yr in real estate taxes, and the city decides they want a private developer to raze your house and replace it with an apartment building which pays $10,000 a year in taxes, they can go ahead and demand your house from you - at fair market value of course. And you can't stop them. Whatever you think of the wisdom of
Kelo it is now the law of the land.
Whether a mortgage can be seized as "property" for the "public good" may ultimately end up being answered in court. As noted, the banks have already filed a lawsuit (U.S. District Court, Northern District of California, Wells Fargo Bank, National Association, as Trustee, et. al. v. City of Richmond, California and Mortgage Resolution Partners Llc, Case No. CV-13-3663).
But we're not going to find out just yet. This lawsuit was "put on hold" Thursday, September 12th, 2013 by Judge Charles Breyer because, duh, no mortgages have yet been demanded - let alone seized - by Richmond. Nor could they be by law without further deliberations and a vote to proceed by Richmond's City Council. Said Judge Breyer
I don't believe it's ripe for determination.
How Do the Banks Lose?
The question remains - why is Wall Street so frightened? After all, investors are being paid fair market value for the mortgages they are holding. They really should be pretty much indifferent (by definition) to whether they continue to hold them or not.
No, the panic resides with the banks themselves. In most cases banks don't actually own these mortgages (as we all recall, mortgages were and for all we know continue to be sliced and diced, repackaged into traunches by banks, then fraudulently sold for more than their actual value to investors across the world). What the banks then do is SERVICE these mortgages. They get paid fees for collecting mortgage payments; if a home goes into foreclosure, they get paid to handle all the foreclosure proceedings.
If a bank is no longer servicing a mortgage, it is no longer receiving money. It can no longer anticipate a nice juicy fee if it has to (Gods forbid!) foreclose. And since money makes the (banking) world go 'round, Wall Street's banks are both terrified and outraged that one of their sweetest revenue streams could be threatened.
So greed. One of the three principles upon which Wall Street is based. (The others being greed and... greed). Wall Street wants to squash Richmond before cities around the country decide this just might be a way to help their citizens too.
Richmond almost buckled. After all was said and done in that seven hour City Council meeting, its members voted 4-3 in favor of continuing on with the process of exploring the program. Four Council members - including its principal proponent, Green Party mayor Gayle McLaughlin (left), and Council members Jovanka Beckles, Tom Butt, and Jael Myrick - stood up bravely (some say recklessly and naively) to Wall Street's threats.
The fight is far from over. The biggest battles are yet to come. Richmond is looking for partner cities to share the risk of lawsuit settlements if it should ever come to that. And the Mayor needs a fifth, supermajority giving vote - by California law - if she ever hopes to seize a mortgage by eminent domain, not just talk about it.
Just the mere mention has given Wall Street a heart attack. Maybe all it denizens would pack up and leave the planet (Mars needs people) were Richmond's plans to be put into actual practice.
I can't wait to say goodbye.
