Eminent Domain Battle Pits Homeowner Against HospitalJody Shenn and John Gittelsohn
Robert and Patricia Castillo, a California couple who have already had their monthly mortgage payments cut by almost 60 percent, want the city of Richmond to reduce their debt by using its powers of eminent domain. That could be bad for hospitals in Missouri.
The Castillos owe $436,500 on two loans on a three-bedroom home that’s now worth about $125,000. The hospitals are members of a mutual insurer that’s among investors in the Pimco High Yield Fund, which owns a slice of bonds backed by loans including the Castillos’.
Richmond Mayor Gayle McLaughlin said “it’s our community that’s at stake here,” and the eminent domain plan is needed to help her city stem its foreclosure crisis. “There’s no way we’re going to back down on this” under threats from “Wall Street lobbyists,” she said on a call this week with reporters.
At least a dozen cities, still dealing with the fallout of the housing bust, are studying proposals to confiscate home loans and write them down to help homeowners escape oversized debt burdens. Pacific Investment Management Co., which is known as Pimco and manages the world’s largest bond fund, is among mortgage-securities investors organizing a coalition to take legal action to oppose the push, according to three people with knowledge of the discussions.
The program is advocated by Steven Gluckstern’s Mortgage Resolution Partners LLC, which would provide services and arrange for private investment funds that would profit by buying the loans for less than property values, and reworking them.
The firm says it already is advising three other California cities and North Las Vegas, Nevada. Groups representing banks, bond investors, real-estate brokers and homebuilders have said any municipality that takes the unprecedented step of trying to use eminent domain to force sales of mortgages from bond trusts will face lawsuits, while lenders will be reluctant to make any new loans there.
Eminent domain, the right of governments to take private property for the public good while providing fair compensation to the owner, has typically been used to seize real estate, such as to build highways or parks.
Potential usage was expanded when the Supreme Court in 2005 ruled in a case called Kelo v. New London that governments could apply it for economic development, including taking property and transferring it to another private owner as long as they pay for it. States are free to restrict that authority.
Eminent domain has also been applied to intangible assets such as mortgages, said Robert Hockett, a law professor at Cornell University, who has been among the biggest proponents. The federal government used it during the Great Depression, when the Home Owners Loan Corp. took possession of mortgages on family farms in the course of refinancing them, he said.
“In this context what we’re talking about is the public purpose of reversing blight and preventing further blight in certain hard hit cities that have really pronounced, profound foreclosure crises,” Hockett said. “It’s a perfectly garden variety use of eminent domain authority.”
The financial industry disputes that claim.
It’s a “misguided approach” to solving a community’s housing problems, said BlackRock Inc. Vice Chairman Barbara Novick, whose firm is the world’s largest money manager.
“This is a flagrant misuse of an important public policy tool and will have negative impacts on availability of credit and cost of credit for the entire community while helping relatively few homeowners,” she said yesterday in an e-mail. It “will benefit a private-equity firm at the expense of everyday investors in mutual funds and beneficiaries in pension plans.”
Richmond is furthest along in implementing the idea, which was considered and then abandoned by communities including San Bernardino County, California, and Chicago.
Richmond, a city of 106,500 on the eastern shore of the San Francisco Bay, this week said Mortgage Resolution Partners was sending letters to servicers and trustees with offers to buy 624 mortgages. If they refused to sell, the city could then try to use its eminent domain powers to force the purchases.
According to Mortgage Resolution’s program, a private investment fund would buy the loans at prices based on financial models or comparable trades. The mortgages would be reduced and refinanced into new debt insured by the Federal Housing Administration.
The battle is a legacy of the housing bubble that began to burst seven years ago.
About 25.4 percent of U.S. homes with a mortgage -- 13 million properties -- were underwater in the first quarter, according to Zillow Inc., a real estate information service. A combination of foreclosures and the housing recovery has reduced the number of homeowners owing more than the value of their properties from 31.4 percent in the first quarter of 2012.
Cities considering using eminent domain are worse off than the country as a whole, and proponents say it will reduce blight and costs to communities by heading off foreclosures caused by negative equity.
In Richmond, 47 percent of homeowners with a mortgage were underwater in the first quarter, down from a high of 59 percent a year earlier, Zillow data show. In Irvington, New Jersey, it dropped to 46 percent from 56 percent. The rate fell to 64 percent in North Las Vegas from 81 percent. All are higher than the state averages in California, Nevada and New Jersey.
The rate fell to 41 percent in California’s San Bernardino County, which earlier this year abandoned its consideration of idea, from 53 percent.
Delinquencies have also declined across the U.S. as more borrowers regained equity in their homes and the economy improves, according to data provider CoreLogic Inc. Completed foreclosures fell 20 percent to 55,000 in June from a year earlier. In Richmond, there were 47 pre-foreclosure filings this year through May, down 64 percent from the same period last year, CoreLogic data show. In North Las Vegas, pre-foreclosure filings dropped 44 percent to 57 properties during the same period. That compares with 175 filings in the Nevada city in one month, August 2009, at the peak of the housing collapse.
Policy makers and lenders have been reluctant to embrace principal reductions to aid borrowers, arguing it’s not necessary and may encourage more defaults. Most modifications lower interest rates, extend the terms or take other steps to lower monthly costs without reducing the total amount owed.
Loan modifications that included a principal reduction accounted for about 1 percent of the 515,000 loans renegotiated by banks in the 12 months through March 31, according to a report by the Office of Comptroller of the Currency.
Patricia Castillo, 41, said she feels trapped in the house that she and her husband bought in Richmond for $420,000 near the height of the housing boom in 2005, because they have no equity and no money to repair the deteriorating property.
“I feel like we’re just renting,” she said in a telephone interview from the home, where she cares for her 24-year-old son, Leon, who is disabled. “I’m not building any equity to fix the house. It’s like it’s not our house.”
Castillo and her husband Robert, 44, a school bus mechanic, received a loan modification in 2009 from their loan servicer that she said reduced monthly payments to $1,543 from about $3,700, including both their first and second mortgages. Under the new terms, including interest-only payments on the first loan of $638, their monthly obligations will rise to $1,862 in November, $2,181 a year later and $2,460 a year after for the rest of the loan.
Their mortgage was bundled into a bond transaction known as Lehman XS Trust 2006-GP4, according to a note to clients this week by RBS Securities Inc. strategist Scott Gimpel. The information he assembled on the loan was from CoreLogic and public records.
The Castillos put no money down in buying the property, received their original modification four months after falling behind on payments and are now paying less than half on their first mortgage than it would cost to rent in the area, according to Gimpel. He wrote that they refinanced in 2006 into a type of mortgage that meant their balance would grow, causing the first-lien monthly payments to rise from $1,114 to $2,065 in 2008.
Castillo said they need to own their home because their son needs a safe place where they aren’t subject to a landlord. She said their lender deceived them when they originally got their mortgage, which is why they support Richmond’s eminent domain effort.
“We didn’t know any better,” she said. “I feel they should pay the consequences for giving us that loan.”
The $17.3 billion Pimco High Yield Fund is invested in one tranche of the Lehman XS Trust securities, and an investor in that fund is the Missouri Hospital Plan, according to data compiled by Bloomberg. The plan describes itself as the leading writer of medical professional and general liability insurance for the state’s hospitals, their employees and related entities.
If the loan is acquired for too low of a price, it could lower the bond’s yield, and returns in the Pimco fund.
Lower investment income could raise insurance costs for the plan’s members, though “you’d have to look at it in the context of the overall portfolio,” said Joe Moody, chief executive officer of the HSG Family of Companies, which manages it.
The Castillos aren’t the only Richmond residents who say they are hoping for smaller loans through the use of eminent domain after previously receiving reductions in their payments.
Morris LeGrande got his loan reworked in 2009 under the federal Home Affordable Modification Program, he said on the July 30 call with reporters. Next year, his monthly payment will rise by $300, he said.
“It will put me close to $3,000 a month to pay for a home that is currently valued at $130,000, and in 27 years there’s a balloon payment due of $194,000,” he said. “So effectively, I’m a homeowner by a technical expression only. I will never be able to pay for this home under the current conditions.”
A government watchdog this month criticized the HAMP program, finding that more than 300,000 homeowners defaulted again after getting modifications. At the same time, monthly data from the Treasury Department shows that fewer than a quarter have been sent to foreclosure proceedings.
More than 31 percent of borrowers got additional modifications, 5.1 percent were put on separate repayment plans to catch up and further actions are pending on 16 percent, the data based on a survey of eight servicers show. Eight percent became current on their loans again without new aid, and 0.9 percent paid off their debts.
Of the 624 loans being targeted in Richmond, 444 are currently being paid on time, according to Graham Williams, CEO of Mortgage Resolution Partners.
Not every underwater mortgage should be targeted, according to Cornell’s Hockett. Those at risk of future foreclosure can be identified and bond investors made happy, he said.
“There are some of these loans if you write them down it renders the homeowner and the bondholder better off,” he said. “If that premise is correct, there’s no reason you can’t have an amicable agreement.”
The industry is wary of that view and Hockett said that he has been unable to persuade federal regulators to back a mediation process.
The 32 servicers and bond trustees that oversee the loans aren’t likely to sell willingly, according to Chris Killian, head of the securitization group for the Securities Industry and Financial Markets Association, Wall Street’s largest lobbying organization. That’s because of the nature of the bond contracts and their view that it’s generally a “bad idea.”
Along with Pimco, other members of the coalition of mortgage-bond investors working with law firm Ropes & Gray LLP include BlackRock, according to the people, who asked not to be named because the talks are private. MetLife Inc., TCW Group Inc. and Legg Mason Inc.’s Western Asset unit also may join, they said. Fannie Mae and Freddie Mac are considering the idea, depending partly on their regulator, the people said. Spokesmen for the firms declined to comment or didn’t return messages.
Richmond Mayor McLaughlin said on the call with reporters that she would take the industry to court for illegal redlining, or restricting loans in certain areas such as minority or low-income neighborhoods, if they make it harder to borrow in her city.
Any use of eminent domain would necessarily involve court oversight to determine if fair prices are being paid, which is why investors shouldn’t be concerned that the values will be too low, according to Mortgage Resolution Partners.
“Of course we’ll see you in court,” Chief Strategy Officer John Vlahoplus said in a telephone interview. “We’ll sue you first.”