Thursday, August 23, 2012
It’s an idea so crazy it just might work.
It was born with a bunch of rich liberals with consciences who were demoralized at the state of the nation and of what they generally describe as the unwillingness of those with power (Wall Street and politicians backed by Wall Street) to help those who have none (a healthy percentage of everyone else). They sat around, mulled over the country’s biggest problems and tried to come up with one thing they could attack. The goal was to use their collective brainpower, get buy-in from some equally rich and conscientious friends and make just one seemingly insurmountable problem better.
The target they ultimately arrived at: Homeowners underwater on their mortgages – owing more than the house is worth – but still paying every month because they don’t want to walk away from their homes or the community. The idea is to help those homeowners by facilitating the reset of their mortgages, the theory being that once an underwater mortgage resets, a homeowner is less likely to give up on a property that’s no longer worth as much as it once was.
The reset will lower the homeowner’s payment, come with a new loan and a better interest rate and even put more money into the homeowner’s pocket. The homeowner will have more money to save or spend in the community.
All it’s going to take is for local governments to use their powers of eminent domain to acquire the underwater mortgages from the trusts that own them.
But these guys? They’re about to get their asses sued off. The financial services industry is already teeing up against them – and against a project that hasn’t really even gotten off the ground.
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The group raising this lightning rod calls itself Mortgage Resolution Partners. While an altruistic streak is at the heart of their proposal, make no bones about it – there’s also money to be made, potentially billions of dollars. Located in San Francisco and led by venture capitalist and tech entrepreneur Steven Gluckstern – and with about 50 financial backers that include former San Francisco Mayor Willie Brown and investment banker Don Putnam – Mortgage Resolution Partners has been working on the concept of using eminent domain on underwater mortgages for nearly two years.
The idea would work like this.
Local governments would target those underwater mortgages backed by what are called private-label securities – the not-quite subprime (but close to it) mortgages issued to homeowners who maybe had less than ideal credit histories or credit scores. Such mortgages are bundled into pools and held in trusts for bondholders, and aren’t backed by Fannie Mae, Freddie Mac or the Federal Housing Authority. They’re also not bank-issued mortgages.
“Think Countrywide at its prime,” Gluckstern says. An affable, animated man of 61, Gluckstern worked on Wall Street for Lehman Brothers, then went on to run the insurance wing of Warren Buffett’s Berkshire Hathaway (and, at various times, also ran a hedge fund, a medical-device company and co-owned the New York Islanders hockey team). “These are the loans that the government wouldn’t guarantee,” he says.
Gluckstern describes a potentially ideal case: A homeowner who bought a home for $400,000 and took out a loan for $300,000 wakes up after the economy imploded to find the home is now only worth about $200,000.
“This is the homeowner who is trapped. He can’t move, he can’t refinance, he can’t do anything. He’s just stuck,” Gluckstern says. “He can short-sell his house and move out, you know, but say he wants to still live in Salinas. He used to buy at the local bookstore and he used to go out to eat and he used to hire a handyman to help him fix his pool. Now he can’t afford any of that.”
Since negative equity is the greatest single predictor of default, it becomes a numbers game, not only for the homeowner, but for the bondholders backing the loan as well.
“The loan ain’t worth $300,000. That seems pretty obvious because the house is only worth $200,000,” he says. “And you have to say, ‘How long will the homeowner keep paying on their $300,000 loan?’ Because when they stop paying and you have to foreclose and pay all the costs of foreclosure and then resell it, how much money will you get? What’s the loss severity? And then you discount that further because you’re going to be holding it. That’s when the bond reflects the real value of the mortgage.”
Under the Mortgage Resolution Partners’ plan, a local government using eminent domain would acquire the qualifying mortgage. Using the $300,000 loan and $200,000 value for purposes of discussion, Gluckstern says, the local government then pays about 80 percent of the home’s value ($160,000), which is the fair-market value. The loan is then written down to $195,000 and the homeowner gets refinanced – at no cost – with a new loan for that amount.
The bondholder is reimbursed for the fair-market value and the new loan is sold into a federally backed pool.
The profit – the difference between the new loan and the 80 percent is then divvied up. The profit pays the local government for the cost of the program, and it pays back the investors.
Mortgage Resolution Partners makes its money by taking a flat fee of $4,500 from the profit to facilitate the transaction.
The problem is whether a bondholder will accept the fair market value at all, or risk the house going into foreclosure which would tank the bond altogether. If the bondholder doesn’t accept that what they’re being offered is fair-market value, the case goes to court.
There are about 55 million total mortgages in the U.S., about 12 million of which are underwater. About 1.1 million of those are private-label backed.
Gluckstern’s researchers estimate about 400,000 of the 1.1 million are in California, where skyrocketing housing prices made those chasing the American dream of homeownership ripe for the private-label mortgage picking. In other words, Mortgage Resolution Partners stands to make upwards of $2 billion in California alone.
And with about 4,000 underwater, private-label backed mortgages in Monterey County, Mortgage Resolution Partners could make about $18 million here.
That is, if anyone in government, including Monterey County itself or officials from any of the county’s cities, buys into using eminent domain – the nuclear weapon of government power – to help people stay in their homes.
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“This story is about what a local community can do to fix a problem that, if it just sits around and waits, nobody is going to fix,” Gluckstern says. “You can’t keep waiting around for everybody else, because if we do nothing will happen.”
There’s some pretty decent evidence to bear that out. Edward DeMarco, the acting head of the Federal Housing Finance Authority and thus the conservator of Fannie Mae and Freddie Mac, in July fired off a letter to Congress in which he affirmed his wholesale opposition to a mortgage principal reduction plan. He did it despite an FHFA analysis that shows principal reductions could help 500,000 homeowners and save taxpayers $1 billion. Critics calling for President Barack Obama to kick DeMarco to the curb escalated their cries when, on Aug. 9, DeMarco threatened to act against local governments if they use eminent domain on underwater mortgages.
The FHDA warns the eminent domain plan “could have a chilling effect on the extension of credit to borrowers.”
Mortgage Resolution Partners first floated this idea to San Bernardino County, where an estimated 50 percent of borrowers are underwater. The county set up a Joint Powers Authority known as the Homeowners Protection Program JPA; on Aug. 16, San Bernardino County Chief Executive Officer Greg Devereaux authorized staff to put together a Request for Proposals with the nebulous goal of preserving ownership for homeowners with negative equity.
County spokesman David Wert says it’s nebulous because while the eminent domain idea is the most explosive idea under consideration, it doesn’t have to be the only idea.
“We don’t want to give the impression we have something specific in mind. If anyone has a better idea, we’re very eager to consider it,” Wert says. “The Wall Streeters have been going crazy… burning the midnight oil trying to come up with some whizz-bang solution.”
When news of the eminent domain idea first broke this summer, Wall Street really did go crazy. The Securities Industry and Financial Markets Association (SIFMA), a powerful financial-services industry group, almost immediately hired the law firm O’Melveny & Myers to write an opinion; it says the MRP plan is hopelessly flawed, both legally and structurally, and won’t survive a judicial challenge.
But now, SIFMA and a variety of bankers and mortgage industry reps are showing up to the JPA meetings. They’re still opposed to the Mortgage Resolution Partners’ plan, though, and if they’re coming up with another solution, they haven’t gone public with it.
SIFMA still contends seizing mortgages would cause losses to public pension plans, 401(k)s and even individual investors. “In our view, the JPA should work to address issues… more broadly,” reads a statement from Tim Cameron, managing director of SIFMA’s asset management group, “in a way that would actually provide assistance to borrowers in near-term danger of foreclosure.”
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So what about that eminent domain nuclear weapon? One argument posed by SIFMA is that using it to acquire mortgages would constitute an abuse of the process and possibly violate the Constitution. But one local expert in eminent domain law says two things are required for an eminent domain proceeding: The party being taken from (in this case, the bondholder) has to be compensated fairly, and there has to be a compelling community benefit for the property to be seized.
Here the compelling community benefit is keeping more houses from going into foreclosure, and pumping more money into the community.
And while he can’t say absolutely yes or absolutely no to the plan, Monterey attorney Michael Stamp says it’s an idea worth examining.
“It’s a bold and non-traditional idea, and I think it’s going to run into opposition from people who are more familiar with the traditional application of eminent domain,” Stamp says. While working as an attorney for the city of Oakland in the 1980s, he helped initiate an eminent domain case against the Oakland Raiders to keep the team from moving to Southern California. While it took five years to litigate, and the city eventually lost, appealed and lost again, the case also made history.
“It’s when you start to get creative with eminent domain that people start to fight back against it,” Stamp says. “But eminent domain can be a very powerful tool for government to do what needs to get done.”
As it relates to mortgage assistance: “It’s clear that regulatory efforts haven’t helped yet. If I were defining eminent domain in this case, I would define it as used for the purpose of stabilizing neighborhoods and protecting the economic interest of the community.”
Monterey County Chief Administrative Officer Lew Bauman says while he’s heard of the MRP proposal, he doesn’t intend to pursue joining the JPA.
“I don’t think government is structured to enter the housing market at that level,” Bauman says. “Counties are struggling with so many issues. A key one for us is AB 109 (which sends more prison inmates back to county jails) and we’re woefully underfunded. We’re dealing with healthcare reform, pension reform, the general overall economy… to enter into this plan would not seem like a prudent course of action.”
Most of the private-label security-backed mortgages in Monterey County are actually in the city of Salinas, where 3,083 homeowners have such mortgages and are underwater. In the 93901 zip code, which covers South Salinas, there are 576 such mortgages, 440 of which are underwater.
Hardest hit is the 93906 zip code, which has 1,249 private label-backed loans, 1,017 of them underwater.
Salinas Mayor Dennis Donohue says he’s heard of the Mortgage Resolution Partners plan and calls the idea intriguing. He’s asked city staff to start investigating to see if it could work for Salinas homeowners.
Gluckstern shakes his head at the notion that local governments might not buy into the plan.
“Why not join?” Gluckstern says. “Except for the threats of SIFMA, there is no downside.”
Maybe threats from the industry that helped create the housing mess in the first place will be enough to keep the plan from getting off the ground. Or maybe the plan will battle its way to fruition and become the thing that will keep Monterey County from falling deeper into the recession’s grip.
“The people who have caused the problem are refusing to address it,” Donohue says. “If the feds won’t act, maybe the cities should.”