Bondholders See Eminent Domain as State Attack: Mortgages
Bond investors who will be needed to reduce taxpayers’ role in U.S. mortgage lending have a new reason to stay away: the threat of outright confiscation by local governments.
A plan under consideration in San Bernardino County, California, would use a local government’s eminent domain authority to confiscate and write down mortgages for borrowers who are underwater on their loans, meaning they owe more than their houses are worth. The plan would raise borrowing costs and deter private lenders from returning to the $10 trillion mortgage market, according to bond buyers such as Pacific Investment Management Co. and AllianceBernstein LP.
“If you know that the county in which you make a loan could force you to sell it for less than it’s worth if it goes underwater, then the rate you will charge, in a free market system, would be a lot higher,” said Mike Canter, head of securitized assets at New York-based AllianceBernstein, which oversees about $400 billion.
About 11.4 million American borrowers -- 24 percent of homeowners with a mortgage -- were underwater as of March 31, according to Corelogic Inc., with prices down 34 percent from their July 2006 peak. In San Bernardino County, about 150,000 homeowners or half of all houses with a mortgage are underwater and the area’s economic struggles helped push the city of San Bernardino, the county seat, to decide to file for bankruptcy protection.
Private mortgage securities now fund less than 1 percent of new loans, down from more than a third before the housing market collapsed in 2007. The U.S. government currently backs about 90 percent of home loans, and politicians from both parties say they want to reduce that number.
Advocates of the San Bernardino eminent domain proposal, led by San Francisco entrepreneur Steven Gluckstern, argue it will fight neighborhood blight and help speed the pace of the housing market’s recovery from a six-year slump.
Confiscating the mortgages to reduce the principal for borrowers, while paying investors “fair value” for the loans, will stabilize home prices and thereby fuel issuance of private securities, said Gluckstern, whose company-provided biography describes him as an initial member of the national finance committee for President Barack Obama’s 2008 election and a former general manager of reinsurance operations at Warren Buffett’s Berkshire Hathaway Inc.
“In our view, this is helpful, not harmful,” Gluckstern, former co-owner of the National Hockey League’s New York Islanders and current chairman of Ivivi Health Sciences LLC., a medical technology company in San Francisco, said in a telephone interview. “There haven’t been very many good solutions to this in six years.”
San Bernardino officials last month approved an agreement that allows the county and the cities of Fontana and Ontario to create the program being pushed by Gluckerstern’s firm, San Francisco-based Mortgage Resolution Partners LLC, which targets only borrowers who have been making on-time payments and have loans held in mortgage bonds without government backing. The first organizational meeting of a so-called joint-powers authority was today.
Mortgage Resolution Partners would charge flat per-loan fees to the municipality for managing the program, and is seeking to line up financial backers that would fund the purchases and share profits when reworked loans get sold after refinancings with the municipalities. San Bernandino officials will award contracts only after public review, according to county Chief Executive Officer Gregory Devereaux.
Devereaux was elected chairman today of the joint powers authority set up to explore creating a so-called Homeownership Protection Program. Officials will next meet on August 16.
During a comment period at today’s hearing, Brenda Meyer, owner of Cozy Cabins Realty, said that the plan “may appear to be a solution on the surface but for every action there’s a reaction,” warning private lenders will abandon the county.
Tim Cameron of the Securities Industry and Financial Markets Association, whose members include asset managers overseeing more than $20 trillion, said that officials should remember pension plans and individual investors may be harmed. In addition, county residents will find it “harder or impossible to obtain credit” and need to bear the costs of “lengthy and expensive litigation with the holders of mortgage loans.”
Officials from the California Bankers Association, Inland Valley Association of Realtors, Association of Mortgage Investors and an individual county resident also spoke against the plan at the meeting.
The American Securitization Forum trade group separately told the San Bernardino County Board of Supervisors in a letter today that the idea will be “short-sighted and ultimately be counterproductive for the residents of San Bernardino County. Moreover, it would violate both the United States and California Constitutions.”
Governments across the U.S. and countries such as Great Britain and Canada have used the powers of eminent domain for centuries to condemn and seize property and compensate owners for their losses. The practice has been upheld by the U.S. Supreme Court in cases of a “legitimate public use,” according to Robert Hockett, a professor of law at Cornell University, who argued for extending the practice to condemn mortgages.
Gluckstern’s plan has gained support from Yale University professor Robert Shiller, co-creator of the S&P/Case-Shiller index of home prices. Shiller, who warned of the housing bubble before its collapse, argued in a New York Times op-ed that “we have to stop the wishful thinking that the problem will solve itself through a spontaneous rally in home prices.”
Origination of private-label loans, which accounted for about one-third of the mortgage market in the middle of the last decade, dried up in 2008 as defaults began to soar. The delinquency rate of private label loans peaked at 32.7 percent in August and fell to 30.6 percent as of May according to data compiled by Bloomberg.
Many of the investors who are concerned their bonds will lose value if the plan is carried out bought the securities they hold at steep discounts after the market crashed, Gluckstern said. Typical prices for the most-senior bonds tied to so-called option adjustable-rate mortgages rose last week to 55 cents on the dollar from a record low 33 cents in 2009, according to Barclays Plc data. Option ARMs allowed borrowers to pay less than the interest they owed by increasing their balances.
“The only thing that keeps the prices as high as they are is actually the performing loans, the exact loans that it appears are being targeted for condemnation,” said Paul Jablansky, who heads structured products at Pasadena, California-based Western Asset Management Co., the bond unit of Legg Mason Inc. that oversees about $450 billion. “Securitization investors could pull back dramatically.”
Issuance of securities backed by new home loans without government backing peaked at about $1.2 trillion in each of 2005 and 2006, or more than a third of total lending, before halting in 2008 as defaults on the debt fueled a global crisis, according to industry newsletter Inside Mortgage Finance. Deals have totaled about $3.5 billion since 2010, when the market restarted, according to data compiled by Bloomberg.
Democratic and Republican lawmakers in Washington say they want to eventually reduce government involvement in the mortgage market, which would require more private securities.
“If the government wants to back down from its more than 85 percent share of the mortgage market to 50 percent or lower, it’s going to require the private-label market to be embraced by a larger number of institutional investors,” said Michael McMahon, a managing director at Redwood Trust Inc., a Mill Valley, California-based issuer of private mortgage securities. “And if they can’t model cash flows because they expect unexpected wrinkles like this, they’re just not going to invest.”
Some bond investors spent the past three years complaining that government actions subvert their contractual rights, favor banks or damage their holdings.
“What people really need to understand is you’re sowing the seeds of significantly higher interest rates,” said Mark Goldhaber, who spent 20 years at mortgage insurer Genworth Financial Inc., including as its government affairs chief, before leaving this year to become an independent consultant in Raleigh, North Carolina. “Investors are going to say, look at all the things you’ve done. We’ve got to price for them.”
Pimco is among investors that say they support greater targeted use of principal forgiveness on loans backing their bonds. Still, it sees the use of eminent domain as putting “another nail in the coffin of the private mortgage market,” said Scott Simon, its mortgage head. “It just means you’re going to need to have monster credit scores and monster down payments if you’re ever going to have a private market.”
Investors’ ire has been building since a 2008 settlement between Bank of America Corp.’s Countrywide Financial unit and state attorneys general in which claims of predatory lending yielded a deal that called for mostly investor-owned loans to be reworked, Goldhaber said.
Since then, state and federal governments have taken a series of steps to freeze or slow foreclosures. Congress passed a law protecting servicers from investor suits and the federal Home Affordable Modification Program was structured in a way that aids lenders, according to bondholders.
Pimco and BlackRock Inc., the world’s biggest money manager, publicly objected to the terms of a $25 billion state and federal settlement with mortgage servicers over foreclosure abuses that allowed five of the largest U.S. banks to rework loans owned by investors. Servicers can rework debt owned by bondholders without forcing the banks to wipe out second-lien home-equity debt that the lenders hold.
California Governor Jerry Brown signed the “Homeowner Bill of Rights” on July 11, extending the February settlement terms to all servicers in the state, which has the highest number of delinquent and underwater mortgages.
“By doing what they’ve done, you really discourage private capital from coming in down the road,” BlackRock Vice Chairman Barbara Novick said. “From a long-term perspective it’s not serving the interests of our economy and taxpayers.”
BlackRock declined to comment on the eminent domain issue, said Lauren Trengrove, a spokeswoman.
Under mortgage bond contracts, servicers and trustees probably have no obligation to object in court to the prices offered in loan seizures, forcing investors to accept amounts that are too low, according to Amherst Securities Group LP analyst Laurie Goodman. The New York-based analyst testified June 7 to Congress that underwater borrowers need their loan principals reduced to aid a housing market recovery.
Mortgage Resolution Partners has told potential investors that it will target paying 75 percent to 80 percent of a home’s market value for the mortgages seized through eminent domain, Goodman wrote in a report.
“If a nonprofit did it you could, in theory, do it on terms that were fair but not generous to investors, but I don’t like the use of eminent domain and there’s nothing you can do that will work for MRP and work for the other parties,” she said.
In a frequently asked questions document used for Mortgage Resolution Partners’ marketing, the firm said it might use a “quick take” process in which courts would approve a loan seizure and let the price be determined afterward.
Mortgage Resolution Partners is factoring in “extensive” legal costs and is prepared for a fight, according to the document.
“We hope they will come to recognize the program is the best way to resolve the troubled loans in the securitizations for the benefit of all parties involved,” the document said.
Paul Herrera, government affairs director for the Inland Valley Association of Realtors, said at the hearing today that the firm played too big a role in the push and that officials had been too secretive in moving forward with its ideas.
“Entire communities could be caught in the blast radius of this eminent domain detonation,” he added