Mortgage malaise: US banks taste their own medicine

City governments are reinterpreting the law to seize underwater properties from banks and replace them with cheaper loans. But some analysts worry about the broader market effects.

FT.com

The Godfather flashes silently on the TV as Steve Wilson sips a tequila and apple juice cocktail, clutching a letter from the property assessor.

The house he bought 11 years ago for $280,500 is worth $137,000 today. Factoring in the loan that added interest to his principal, and deferred property tax bills that accrued when he was sick with colon cancer, the part-time automotive repair salesman is now paying off a $300,000 mortgage.

“I’ll be dead long before then,” the 54-year-old says; the screen behind him showing a mob boss whispering threats of a shakedown. The walls in the kitchen are rotting from termite damage and mould, while police sirens wail through Richmond, California, a working-class city 18 miles from San Francisco rife with unemployment and crime.

The city government is fighting to finance Wilson and his neighbours. His address is included in a list of more than 600 properties it wants to take over with the help of Mortgage Resolution Partners, an investor group that is advised by Evercore Partners, which plans to arrange funding for cities that want to compulsorily purchase loans, and Westwood Capital.

The pair have teamed up in a controversial scheme to wrest the housing loans away from JPMorgan Chase, Wells Fargo and 30 other banks by relying on a novel interpretation of eminent domain laws, an idea spearheaded by MRP, which it started pitching last year. Richmond is being closely watched as a test case by other cities across the US considering the plan.

Municipalities have historically used the law to seize private properties when the land is needed for a public project, paying the owners fair market value of the home. In Richmond, and in several other US cities worried about mass foreclosures, officials plan to use the law to seize underwater mortgages from banks and replace them with new, cheaper loans based on current home values to relieve the debt burden on cash-strapped citizens.

“Homeowners are at their wits end,” Richmond’s mayor, Gayle McLaughlin, says. “Federal programs have not provided relief. We have tried working with the banks for five years. Only a few mortgages have been modified.”

She says the housing crisis has rippled through the city’s economy. When residents struggle to meet high monthly mortgage payments they do not spend money with local businesses. As homes go into foreclosure, nearby property values go down, generating less tax revenue for the city, and more crime.

John Vlahoplus, chief strategy officer for MRP, said the firm would make a flat fee of $4,500 per loan, and would make a return for its investors only if the scheme spread to multiple cities and 10,000s of loans across the US. “We thought from the beginning that eminent domain would be the tool that would get everybody to the table,” he said. “Nobody is making any decisions on these loans, there are conflicts of interest and inertia and a slow grind towards foreclosing on people.”

Newark, New Jersey, Seattle, Washington and several others are considering a similar plan, provoking an angry reaction from investors who buy mortgage-backed securities, bonds backed by pools of home loans. If it turns out the underlying collateral can be seized by local governments, they say there could be major disruption in the mortgage-backed securities market, with knock-on consequences for the availability of mortgages.

But Daniel Ivascyn, who runs the $28 billion Pimco Income Fund, one of the biggest bond investors, and head of its mortgage credit portfolio team, said the scheme threatens to raise mortgage costs for all US citizens. “One significant policy concern is the chill that this puts across the housing finance markets more generally,” he says. “Investors will require additional compensation in the form of yields or spreads, if you have this uncertainty and additional complexity.”

With backing from Pimco and a coalition of other investors holding securities that will be affected, Wells Fargo and Deutsche Bank sued the city of Richmond last week in their capacity as trustees. The case, filed in the district court for the Northern District of California, claims the proposal violated the US Constitution and imposed losses on pension funds and individual savers totalling $200 million in Richmond, and “billions of dollars” more if the plan were rolled out across the country.

The Federal Housing Finance Agency, which controls the government agencies Fannie Mae and Freddie Mac that backstop the majority of US mortgage-backed securities, has even threatened to pull out of areas that approve the use of eminent domain, which would dramatically reduce the availability of mortgages to new borrowers.

Richmond officials are undeterred and MRP has agreed to back all legal costs. The mayor says the city vetted the plan with lawyers and scholars and is confident the legal reasoning is sound.

“FHFA lacks statutory authority to dictate what cities may do to solve our local foreclosure crises,” McLaughlin said, adding that because the vast majority of Richmond residents are Latino or African American, pulling out of the city would amount to “redlining,” a discriminatory denial of services.

Tom Butts, a member of Richmond’s city council for 18 years, said the banks’ lawsuit only emboldened the effort on a political level.

“The banks caused the whole financial meltdown that resulted in the Great Recession,” he says. “They all got bailed out by the government. For them to come back and try to attack a very well thought out and very creative scheme to try to bail out some of the people who were their victims is extremely cynical and extremely hypocritical.”

For homeowners in Richmond, the concerns are more practical.

After Wilson received chemotherapy to treat his colon cancer, he suffered nerve damage in his feet, forcing him to give up his auto repair business. He collects social security and disability benefits, and works part time in sales, but still feels the weight of his monthly mortgage payment.

Community organisers have visited him to rally support for the eminent domain plan, but he is wary of the political arguments and assertions that the banks want him to fail so they can collect the insurance in his loan. For him, any plan will do as long as it has one basic criterion.

“I’m in it for me,” he says. “If it cuts my payment in half, I’ll go along with the program.” He rattles the ice in his tequila and tips the cup toward his lips. “I’m just a simple little dude.”

Copyright the Financial Times 2013. 

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