LOS ANGELES -- Richmond, Calif.’s plan to keep homeowners out of foreclosure by seizing underwater mortgages through eminent domain is unlikely to be successfully implemented, according to Moody’s Investors Service.
The San Francisco-area city, with a population of about 100,000, announced the adoption of its controversial plan on July 30. Under the plan, Richmond would invoke the power to take private property for public use to seize underwater mortgages — loans that have a higher balance than the value of the home — held by private-label residential mortgage backed security trusts, for significantly discounted prices.
“We believe successful implementation of Richmond’s plan and widespread adoption by other cities is unlikely because rising home prices are undercutting the city’s rationale for the program, most cities will find the plan unattractive and the plan will face legal challenges by market participants,” Moody’s analysts said in a report released Monday.
The agency still views the city’s plan as a credit negative for U.S. RMBS because if the city does execute the program successfully, it would encourage other cities to adopt similar plans that would increase losses on RMBS.
Other cities reported to have been considering the plan include El Monte, Calif., Irvington, N.J., Newark, N.J., North Las Vegas, and Seattle. Both San Bernardino County and Chicago, under worse economic conditions, have considered the plan, but eventually rejected it, Moody’s said.
If implemented, Richmond would become the first government to move forward with such a plan.
“If only Richmond and a handful of other cities implement the plan, overall losses to RMBS will be small,” Moody’s said. “In the event that the plan becomes widespread, which we do not expect, losses would be significant.”
The concept was created by a San Francisco firm called Mortgage Resolution Partners, which has marketed the plan to cities and local governments for more than a year.
According to Richmond Mayor Gayle McLaughlin, the city would offer to purchase a homeowner’s mortgage from the lender at fair market value, as assessed by Mortgage Resolution Partners, and if they do not accept the offer, the city would use eminent domain to seize the mortgage at the “fair market price.”
The city would take the mortgage and renegotiate a new loan for the homeowner at a lower principal and lower payments.
Both the city and Mortgage Resolution Partners would earn a fee, which would come from the difference between the price paid for the seized mortgage and the higher price at which the loan is refinanced.
As home prices improve, however, this plan has become less justifiable, Moody’s said. Loan-to-value ratios have been declining and home prices have been rising since 2012 in Richmond and other cities that are considering the plan, Moody’s said. As a result, borrowers will have less negative equity and will be less likely to default.
In addition, the use of eminent domain, which has historically been used by governments to take private property for public uses, including highways and economic development, has been widely criticized by market participants. Such criticism could cause negative repercussions for cities that implement the plan.
Lenders concerned about future eminent domain action, for example, would likely restrict credit to borrowers in those cities, demand lower loan-to-value ratios as additional protection against loans becoming underwater, or pass higher costs on to the borrowers. These repercussions will dissuade cities to go through with the plan, Moody’s said.
Industry groups such as the Securities Industry and Financial Markets Association have also said they would fight the legal basis for the plan on the grounds that using eminent domain to seize mortgages is unconstitutional. The groups would also argue that mortgages that are held outside the city are not within the city’s legal jurisdiction to seize.
U.S. Rep. John Campbell, an Orange County, Calif. Republican, reintroduced a bill last week, called The Defending American Taxpayers from Abusive Government Takings Act, that would stop governments from enacting these plans.