California city moves to seize underwater mortgages
The City of Richmond, in the San Francisco Bay Area, is moving ahead with a controversial plan to use eminent domain to acquire mortgage loans from the lenders who currently hold them, at significant discounts from the loans’ face value. The balance of the loans in question exceed the current market value of the homes which secure the loans (i.e., the loans are “underwater” or “upside down” in the lending jargon).
Richmond intends to acquire these loans at less then the market value of the homes, and will then arrange for the homeowners to refinance the loans with a new lender, taking the city out of the transaction at that point.
This project raises many constitutional and policy issues. Over at the Volokh Conspiracy, legal blogger Ilya Somin offers the view that the Supreme Court’s decision in Kelo v. New London, combined with the California courts’ permissive approach to eminent domain, means that Richmond can probably use eminent domain for this seemingly private purpose. Somin comments, however, that the big issue in these eminent domain cases is likely to be valuation: can Richmond really acquire these loans for less than the market value of the homes that secure them?
I would add to Somin’s analysis that these cases will present an important issue of evidence in eminent domain cases. There is a secondary market for mortgage loans, and a mature body of expertise in valuing those loans. In the ordinary course of an eminent domain valuation proceeding, expert witnesses on both sides would offer testimony on what that market establishes as the value of the property being taken.
If there is an active market for underwater mortgages, in which lenders and secondary market participants employ industry standard valuation methods, then that market would establish the value of the loans Richmond is seeking to take. It seems likely that there is some market for these loans, since the loans at issue are being paid regularly. If there is not such a market, then California courts will have to establish how to determine value, and that question will be vexing indeed.
It remains to be seen how Richmond proposes to establish that every one of these loans is worth less than the market value of the security for the loan, but the proposition alone that all of the loans are worth a uniform 80% of the value of the homes suggests that Richmond will attempt to use a novel means of proving value that is not based on an actual secondary market for the individual loans.