The Resolution Law Group: Is Mortgage Seizure Plan a Win-Win or Lose-Win?

Is using eminent domain to pare back underwater mortgage debt a win-win or a lose-win?

It’s a question at the heart of the battle of Richmond, the California city that’s emerged as the staging ground for a high-stakes legal experiment that could reshape the mortgage-backed securities market.

As The Wall Street Journal reports, banks representing some of the nation’s largest bond investors sued Richmond on Wednesday to stop the city from using the power of eminent domain to forcibly purchase loans on several hundred properties.

Under the U.S. Constitution’s “takings clause,” the government may confiscate private property for “public use” as long as the owner is justly compensated. It’s an amount that the U.S. Supreme Court has defined as the market value of the condemned property at the time it was seized.

Figuring out the market value of land is complex. Calculating it for securitized mortgage loans is even knottier.

Richmond is proposing to acquire underwater but performing loans at a price below the market value of the homes; say, for 80% of the home’s current value. The city argues that the price is fair value–high enough to pass constitutional muster. Such a discount is warranted, it says, because many of the borrowers would eventually stop making payments. And higher risk means lower value.

The investors suing aren’t buying that. They think the forfeiture discount is based on an exaggeration of foreclosure risk. They note that the city is targeting homeowners with good credit ratings who are paying their mortgages.

The whole plan, they say, would collapse if the city actually paid a fair price.

“The entire Program is premised on undercompensating the owners of the loans,” states the complaint filed by three mortgage-bond trustees. “It could not function in any other way, because the Program is profitable for its participants only because the loans are seized for heavily discounted prices and are then refinanced with a new loan purportedly worth more than the amount for which the homeowner’s existing loan was seized.”

Mortgage Resolution Partners, the private investment firm teaming up with Richmond leaders, rejects the claim that any investor group would be made worse off, a company spokesman told WSJ.

Cornell University law professor Robert Hockett, the legal brainchild of Richmond’s proposal, says lenders forced to surrender the loans would have the opportunity to scoop them up after they’re refinanced and more valuable. In other words: They have the chance to get in on both sides of the trade, so what’s there to complain about?

“That bondholders will effectively be ‘paying themselves’ less for their loans than face in so doing is just a roundabout way of saying that they will be writing down principal,” he wrote last year in a paper promoting the idea. He says these investors would like to write down the debt on their own, but are stymied by securities and pooling agreements that make it hard to modify individual loans within a trust.

Thanks but no thanks, say bond investors. It’s not that they doubt that the new lenders would make money. (Though some critics of the plan wonder if the litigation costs would chip away at profits.) They fear what happens next. If the eminent domain idea catches on, the risk of loan seizure would tighten credit and undermine confidence in the broader securities market, the lawsuit claims.

So it’s not just a legal question of what’s fair value. The bondholder lawsuit is challenging the constitutionality of the plan in another major respect. It claims the potential harm to securities investors would violate the part of the Commerce Clause that prohibits local governments from excessively burdening interstate commerce.

Mr. Hockett says the investors are the ones exaggerating here. “It’s not clear to me what sense that would burden interstate commerce,” he told WSJ. “It doesn’t prevent credit from flowing in any particular way. If anything it ought to assist with the flow of interstate credit by unclogging mortgage markets.” In his view, a win-win.

The Resolution Law Group is currently enrolling clients into the pending lawsuit. For further information, visit its website at www.TheResolutionLawGroup.com

Lender Litigation, Unlawful Foreclosure, Tarp Money, Mortgage Backed Securities, Derivitives Lawsuits, Insider Trading Lawsuit, SEC Settlements, Ponzi Scheme Lawsuits, Intentional Misrepresentation, Securitized Mortgage, Class Action Securities Lawsuit, Robo-Signing Lawsuit, Lost Equity Litigation, Mortgage Lender Fraud, FINRA Fraud Lawsuit, Suing Banks, Fraudulent Misrepresentation, Short Sale Fraud, Fraudulent Business Practices, Mortgage Litigation, Complex Tort Litigation, Injunctive Relief, MERS Fraud

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