The California city council risking the wrath of Wall Street's homelenders

http://www.theguardian.com/money/2013/sep/24/us-housing-market-mortgages-eminent-domain

Version 0 of 1.

The city council of a San Francisco suburb is at the centre of a US national controversy: reeling from the foreclosure crisis, it is trying to use a novel legal tool to seize mortgages to help its citizens avoid losing their homes.

Richmond, California, a city of 110,000 people, will use the power of eminent domain to take troubled home loans away from financial firms, ignoring dire warnings from the banking industry of unintended consequences. Supporters say the approach would keep people in their homes who otherwise might have lost them, at a minimal cost to taxpayers. Critics warn it could set a precedent that would make mortgages harder and more expensive to obtain across the country.

The decision to proceed with the plan came earlier this month after a night of impassioned debate at Richmond's city hall, where residents were colour-coded by their position. Some wore red T-shirts distributed by plan opponents reading "Stop Investor Greed", others yellow T-shirts distributed by supporters.

At the centre of the debate are the many homeowners who, despite rising house prices, still owe significantly more than their homes are worth. These "underwater" borrowers are at higher risk of defaulting on their mortgages.

Cities can take over a mortgage through the power of eminent domain since the loans are a form of property, just like a house or a piece of prairie. City manager Bill Lindsay explained that Richmond would be using that power as a creative solution for a city racked by foreclosures. It would designate new investors to buy the mortgages with the intention of lowering what is owed to levels more homeowners can afford.

The bond market is already miffed at the city for trying to stiff the investors who currently own Richmond's mortgages. When the city tried to issue $34m in bonds, nobody bought them, forcing the city to withdraw the offering. "When investors have choices in the market, they tend to choose the safe, plain vanilla option, rather than one that requires them to research and fully understand the story," Lindsay said. "Those bonds are called 'story bonds', and investors tend to avoid them."

He says he heard from a few municipal finance experts who said that any nervousness about the eminent-domain plan on the part of investors was "baseless" and should fade away. But as long as Richmond is the only one pursuing the option, it is much easier for bond-buyers to punish the city.

"One of the things that's been really difficult is going forward as a single entity," Lindsay told the council. "We're really the only city right now that's on board with the programme. That is an issue also for you to consider, that right now, we are the only one."

Meanwhile, banks are suing Richmond to prevent it from using eminent domain. And to further deepen the council's worries about forging into unknown territory, Mortgage Resolution Partners – which has lined up investors to take over the loans once they have been seized by the city – has said that while it will pay for Richmond's legal defence, it can't buy insurance to cover a large judgment against the city.

The plan's defenders, most prominently Cornell University law professor Robert Hockett, who designed it, say the city is on rock-solid legal ground and should not fear catastrophic losses.

But that's hardly a sure thing. And for those on the council who remember having to fire a third of the city's workforce after a fiscal crisis in the early 2000s, it's an untenable risk – especially for the lower-income areas that are disproportionately affected by a loss of city services.

"We knew the empire was going to strike back. This is no surprise," said councillor Jim Rogers. "And we have to look at the seriousness of their threats. We have to look at the damage they could wreak … A 1% chance of bankruptcy for this programme is a deal breaker for me."

The meeting largely turned on whether the city should take that chance, sticking its neck out for municipalities around the country that might want to explore eminent domain as well. Two council members staunchly opposed to the plan, Corky Booze and Nat Bates, argued it wasn't worth it.

"We cannot fight with Wall Street and their big money," Booze said. "If we lose in court, I'll be sitting here and say, 'I told you so.'"

Bates agreed: "We are the guinea pig. Is 110,000 people worth fighting Wall Street?"

After the council laid out its positions, 100 people from the audience lined up to take two-minute turns at the microphone. Opposition came from real estate agents and polished businessmen from the posher areas of town fearing the repercussions, but also from some smaller retail associations and those sceptical after learning that many of the 624 homes on the city's seizure list are not in poor neighbourhoods, because of a decision to include underwater homeowners who are current on their payments as well as those who are delinquent.

As the hearing crossed into the early hours, though, more supporters came forward. Ali Marshall said she bought her house 13 years ago, but now it is worth $112,000 less than what she owes on her mortgage. "None of this could've been predicted," she said. "We're paying currently, but any day we could face foreclosure, because of the financial stress. We love our home. It is our first home. My daughter was born in our home. We want to do the honourable thing. We want to pay our debt. We simply deserve a new loan."

At around 1am, the politics of the situation got ugly. Bates and Booze, who are African American, accused white mayor Gayle McLaughlin's Richmond Progressive Alliance of attempting to speak for the black community and derided her black allies on the council as being "not African American". As the race-based squabbling escalated, McLaughlin gaveled the session into a recess to cool things off.

In the end, the council defeated the resolution to kill the eminent domain plan, and approved another one to set up an authority that could administer it. The city is still a long way from actually exercising its power to seize property. "Nothing in life is 100% risk-free," McLaughlin said. "But leadership demands that we sometimes take risks on behalf of our community."

<em>This article appeared in </em>Guardian Weekly<em>, which incorporates material from the Washington Post</em>

Our editors' picks for the day's top news and commentary delivered to your inbox each morning.