Eminent Ripoff

Well the promoters whose idea it was have found a city government that is stupid enough to try their scheme of using eminent domain to rip off mortgage lenders. Not to my surprise, that is the government of the city of Richmond, California.

The idea is that the city will use its power of eminent domain to seize properties with underwater mortgages and then refinance them – regardless of whether they are in default or not. So, for example, a property has $400K of mortgages but a present market value of only $200K. The scheme will seize the property and refinance it with a mortgage of $190K, giving the happy homeowner $10K of equity and a much reduced principal balance. They will then pay the lender $160K and the city and the promoters will share the remaining $30K. Everyone is happy except the lender, who has been paid $160K for $400K worth of mortgages – which are still worth that much as in most cases the mortgages are not in default. The homeowner thinks he is happy – until he gets a bill from the IRS for taxes on $240K in debt reduction, that is.

The assertion is made that this is done to “prevent foreclosure.” What crap. The lender cannot (and has no desire to) foreclose on a loan that is current, regardless of any impairment in the value of his collateral. If a mortgage is not in default, it is still worth its outstanding balance, maybe more if it is at an above-market rate (most likely, given Bernanke’s QE activity). An attempt to seize a current mortgage on the basis that the value of the collateral is the fair value of the mortgage is manifestly bogus. Even if the mortgage is in default, this action forecloses the rights of the lender to adjust the mortgage or make other arrangements to remedy the situation.

I imagine this will be contested in court and will probably be ruled an illegal use of the power of eminent domain, but who knows – this is California, after all. If the city and promoters get away with it, mortgage finance in California will be crushed – no-one will lend on the basis that if the mortgage goes underwater it will, in effect, automatically default with losses substantially greater than implied by the impairment of the collateral value. And I hope someone is providing these homeowners with tax advice (but I doubt it). The temporary relief for mortgage write-offs has expired as of the end of 2012, by the way.

Edit: Bloomberg weighs in.

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