Most areas of California and the United States have been recovering, slowly and in differing ways, from the Great Economic Recession and related real estate loans, low home values and foreclosure problems.
With low interest rates and higher values, more residential properties have gone on sale in a normal way, without foreclosures, short sale restrictions or loss of principal. During 2012 and early 2013, Ventura County residential real property sales significantly increased over sales in 2011 and before.
But, not all of California’s hard-hit regions have recovered quickly. In California, around 20 percent of home loans are still estimated to be underwater, while in Ventura County the total is about 14 percent.
Underwater loans are typically more likely to go into default and foreclosure, and lead to an abandoned or unrepaired property. Borrowers often see no realistic way out of their present loan or high payments, except to just abandon the property (“If we can’t sell it or refinance it, because there is no equity, and the lender won’t discount amounts owed, we will just walk away. At least we get out of that high payment, fees and interest rates…”). Resulting additional municipal expenses make things worse for already-strained city budgets. Cities may be forced to file, or at least consider, bankruptcy, as Stockton and Detroit did.
To avoid these potential underwater loan problems, some argue that a lender should agree to take a discount on old, high-rate loans; residents could then obtain a lower payment loan from a city or new lender, and thereby stay in their homes. This would mean fewer foreclosures, fewer residents forced to move, fewer abandoned properties, and thus less abandoned property expenses for cities to pay. In 2012, a San Francisco company, Mortgage Resolution Partners “MRP”, promoted that idea, suggested by a Cornell University Law School professor, to California cities (including Fontana and Ontario) by. MRP proposed that California cities create an independent agency that would buy troubled loans from lenders at a discount and refinance them into new lower payment loans for homeowners. If the lenders do not sell the loans to the cities for “far less than owed” amounts, cities would use their eminent domain powers to seize the loans/mortgages.
One example: A house worth $200,000 is in default and foreclosure. A city offers to buy the $300,000 first-priority loan on the house for $150,000. If the lender agrees, the city and MRP obtain a $150,000 loan to buy the old loan. They then offer the homeowner a new $190,000 loan with lower monthly payments. If the lender refuses to sell, the city invokes its power of eminent domain, seizes the mortgage, and offers/pays the lender “fair market value” for the mortgage.
In 2013, MRP agreed to implement that plan for the City of Richmond. MRP would receive a fee for each loan, pay necessary funds and pay the city’s legal expenses. In late July, Richmond gave notice to trustees and loan servicers regarding 620 underwater loans on homes within the city, asking that the loans be sold to the city. Richmond approved the creation of a joint-powers authority (possibly to include other cities, like El Monte) to buy back the underwater loans, but it has not yet approved the use of eminent domain to actually seize loans. Other cities, including Newark (NJ), North Las Vegas (NV) and Seattle (WA), have made similar demands.
Lenders and investors should not be expected to just sell real estate loans at a discount, even to a city. In early August, mortgage trustees for institutional investors, including Pacific Investment Management, sued in the U.S. District Court in Northern California seeking preliminary injunctions against Richmond, MRP and others. Another federal action, also seeking injunctions, was filed by California’s Wells Fargo Bank and other financial institutions. The lawsuits allege violations of the “takings” clauses of the U.S. and California constitutions and of California’s eminent domain laws. Wells Fargo has noted that lenders do not have contractual authority to sell underwater loans, particularly as those loans have been pooled with other mortgages to back bonds sold to investors.
The federal government, through HUD, federal government, through HUD, the Federal Housing Authority and Federal Housing Finance Agency, has also opposed municipal mortgage-seizing. It has said that the eminent domain plans “present a clear threat to the safe and sound operations of FannieMae, FreddieMac and the federal Home Loan Banks.” The cities’ plans could cause lenders to not make loans in, or to not buy loans from, those places. The federal government could also restrict lending or make the city-resident homeowners ineligible for new government-insured loans.
Some California cities have started to use other tools to deal with bad-loan properties, including court orders for abatement, destruction or receiverships. In August, Thousand Oaks asked the Superior Court to appoint a receiver to determine the fate of one home, in foreclosure, that was described as a “growing mess” and “nuisance.” The receivership alternative was apparently sought instead of abatement because the city and taxpayers would have to pay for the repair or cleanup. Ventura and Simi Valley are now considering similar court requests.
California cities face many problems, including slow economies, lower tax revenues, internal issues, layoffs, and their homeowner residents’ economic problems. They have been forced to increase fees and decrease services to maintain minimum standards. The added strains of dealing with underwater properties in foreclosure, disrepair or need of costly deferred maintenance or destruction and clean-up, will be too much for those local governments to handle.
But is a city’s use of eminent domain the answer? Those local government efforts are admirable, but they fly in the face of a long-time standard for loans – a lender cannot be forced to accept less than the full amount of the principal owed on a debt. Without that standard, existing since Roman times, lenders would not lend. Commerce, business and home sales would stop.
Perhaps cities can follow the “buy/ownto-rent” business model followed now by many banks and investors like Blackstone Group and American Homes4Rent, which rent out foreclosed homes. Cities’ needs for rental housing, low income housing and a profitable use of underwater loan properties could be met with such a stream-lined and income-producing program.
It does not appear that California cities will be successful using their eminent domain power. Besides being contrary to longstanding commercial practices, cities face the combined opposition of the United States Government and the financial “Powers of Wall Street.” Some other solution, legislative-based or profit-centered or both, is needed to help protect California cities from potential problems relating to underwater residential loans.
Michael R. Sment is a member of the CITATIONS editorial board, and handles real estate, foreclosure and bankruptcy matters from his Law Offices in Ventura, California.