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San Bernardino’s Ingenious Rescue Plan

July 20, 2012
by Lawrence Gulotta

A majority of foreclosures and “underwater mortgages” affect working families.  Both the national AFL-CIO and many central labor councils in Atlanta and other cities as well allies like Jobs with Justice and National People’s Action have been active in anti-foreclosure fights.  We believe that this examination of an innovative  plan to use of eminent domain to solve the problem by San Bernardino County, CA will be of interest to union and community activists.–Talking Union

San Bernardino County California is the 12th most populous county in the United States with a 2011 population estimate by the US Census Bureau of 2,065,377. The unemployment rate is at a 12 year high (1990-2012) of 11.9%, one of the highest unemployment rates in the nation.

In a story appearing on National Public Radio, July 13, 2012, by Yuki Norguci, entitled, County Considers Eminent Domain As Foreclosure Fix, San Bernardino County was ranked fifth-highest in foreclosures statewide. County executives estimate that half of the county’s 300,000 mortgages are “underwater”. A mortgage is “underwater” or “upside down” when the homeowner owes more on their mortgage than the home is worth. These mortgages have a high likelihood of defaulting—and, eventually being foreclosed upon. While some are in the process of foreclosure, many affected homeowners are still paying their mortgages—with little hope that their homes will every recover in value.

An astonishing 494,000 people are at risk of loosing their homes (150,000 underwater mortgages multiplied by 3.29 persons per household-US Census 2011) in San Bernardino county. This represents 25% of the county’s total population, or one in four people.

An “ingenious rescue plan” has been proposed to rescue homeowners facing potential foreclosure, by San Francisco based property consultants, Mortgage Resolution Partners (“MRP”): have localities buy underwater mortgages using their power of eminent domain—and then write the homeowner a new, reduced mortgage. The initial program activity would focus on those homes which are underwater but current on their payments. Participation would be entirely voluntary.

Program draftsmen have noted that the eminent domain option is designed for people who have been “playing by the rules,” enhancing the appeal of the proposal. MRP has employed the investment banks Evercore Partners and Westwood Capital to raise money for the initiative from private investors.

The city counsel of San Bernardino voted this week to seek bankruptcy protection under Chapter 9, Title 11 of the US Code. “Property taxes plunged in San Bernardino because of an avalanche of foreclosure activity during the recent housing bust,’’ said Daren Blomquist, a RealtyTrac vice president. RealtyTrac’s most recent metropolitan-area rankings for June shows the two-county metro area of Riverside and San Bernardino ranked No. 3 in the nation for foreclosure activity, with 8,477 filings. In June, an estimated 27,889 more people faced eviction from their homes (8,477 foreclosure filings multiplied by 3.29 persons per household).

San Bernardino and Riverside counties are moving beyond inequality into a space of a mass expulsion of people from their homes. The foreclosures have created a profound “crisis of confidence” in the local economy, undermining recovery.

When homes are in foreclosure, homeowners stop paying the mortgage and property taxes, creating a fiscal problem for local governments which derive most of their revenue from retail sales and property taxes.

One way of keeping financially troubled homeowners in their homes is by reducing the principal on their mortgages, thus lowering their debt burden and more closely aligning their mortgage with the actual value of their home.

It is believed the proposed Homeownership Protection Program (“HPP”) could:

  • Break the legal straightjacket that keeps mortgages in mortgage backed bonds—securitizations—from being modified;

  • Prevent foreclosures,

  • Stabilize housing prices.

Public discussion of the HPP has only just begun and nothing has been decided yet. Local, state and national media have taken to describing San Bernardino as the “crazy county.”

HPP has generated vocal institutional opposition. Investors holding the mortgages predict the move will backfire by driving up borrowing costs and further depressing property values. The fear of lenders’ “red lining” San Bernardino county has been injected into the debate.

HPP focuses on solving the vexatious securitization problem. Securitization was sold to the public and the political classes as a beneficial way of increasing the flow of mortgage capital to the residential mortgage market. What we got instead were “toxic mortgages.” The mortgages were bundled and sold to investors and serviced by servicers or trustees who didn’t own them. To make matters worse, the banks took an end run around the traditional recording of mortgages with the government for “the entire world to see,” creating their own proprietary and opaque registry, Mortgage Electronic Registration System (MERS), saving recording costs and time and now, we have learned, casting doubt on mortgagees’ identities.

Securitization contracts were never designed by Wall Street to be modified or amended. It is nearly impossible to modify mortgages encumbered by securitization.

The demand for mortgage-backed securities was such that the sales effort required the sale of 500 mortgages to generate just one option for a high income investor to purchase

It has been argued by the county and its supporters that there is nothing to prevent a government entity from using eminent domain to acquire a mortgage. The two core criteria for use of eminent domain are: is the entity paying fair value for the property, and is it for a legitimate public purpose?

Advocates of the use of eminent domain argue that their can be no doubt that keeping homeowners in their homes is a legitimate public purpose. Since the home has dropped radically in value, the mortgage is worth much less than its face value. Mortgage-backed securities are already being sold at 15% to 20% discounts. The figure of $800 billion lost in home values since 2008 is the consensus value estimate among property analysts.

HPP calls for the county to seize the mortgages at a discounted price, approved by the courts, and then offer the homeowner a new mortgage that reflects affordable mortgage loan repayment standards. Under the proposal, the money to compensate the mortgage investors for the discounted value of the mortgages would come from new investors who will partner with the program. The new investors will earn payments received on the seized mortgages prior to re-securitization by the Government National Mortgage Association (GNMA), or Ginnie Mae.

A consortium of county and city governments is promulgating a “Public Authority” to begin the purchase by eminent domain of the first series of performing underwater mortgage loans under the new Program. The seizure of home mortgages, but not the homes themselves, has never been conducted by eminent domain, as far as anyone can tell.

Legal scholars have argued there is nothing to prevent a government entity from using eminent domain to acquire a mortgage. Legal observers have argued that that eminent domain is applicable to any kind of property, including mortgages. However, “there is no clear precedent for using eminent domain powers this way,” editorializes the Wall Street Journal.

For San Bernardino county and the cities of Fontana and Ontario, approximately 45 minutes east of Los Angeles, to consider this program is a clear indication that the depressed housing market remains an urgent problem. County officials have argued that families with underwater mortgages spend less of their incomes on a broad cross section of consumer goods and services, thus slowing down the local and regional economies.

When homeowners are “underwater,” there’s always the risk that the homeowner will “walk away.” Abandoned homes drive down neighborhood property values and create blight. The process becomes self-sustaining by encouraging more homeowners to “walk away” from their failed homesteads. This is what officials see happening in Fontana (pop. 199,028 July 2011-US Census) and Ontario (pop. 166,390 – July 2011-US Census).

Indicative of the crisis faced by the states, many state governors have proposed using their share of the $25 billion National Mortgage Settlement to underpin state budgets instead of aiding families facing foreclosure.

The securitization industry is up in arms about this proposal. Coalitions have been organized by banks and investor groups to discredit the proposal. Other cities are closely watching San Bernardino to see what happens.

Dr. Saskia Sassen, a professor of sociology at Columbia University, has pointed to a mass “expulsion of homeowners” and a “marginalization of modest people” taking place around the country. She and her associates have estimated that potentially 15,000,000 mortgages can be described as “toxic assets.” From 2006 to 2010, she notes, 14.2 million mortgages were in some stage of foreclosure action. These people, she argues, become invisible, move into poorer housing, many are simply lost track of by the US Census Bureau, occupying “slap tent cities” in the desert lands. She estimates the potential number of people left without housing due to foreclosure to be from 30 million to 40 million, nationwide. This, she noted, in a lecture given at the Orfalea Center for Global and International Studies of the University of California Santa Barbara, goes beyond “inequality” into a phenomenon she calls “expulsions.”Professor Sassen asks, “At what point are you on the other side of the curve?”

The “social” has become unstable. Urban insecurity has radically increased. Paradoxically, “modest people” have moved onto the stage of history, their modest, (though not exclusively modest) foreclosed homes, have created an unrelenting “crisis of confidence” in the American Dream. “Powerlessness becomes very complex,” undermining the financial system whose mathematical mortgage securitization models did not allow for such a crisis, in the first instance. “The shape of the curve indicates something else is happening, the US is moving from “inequality to expulsion.”

Prof. Sassen “destabilizes” the very definition of the word, “expulsion.” Ylan Q. Mui writes in the Washington Post, July 8, 2012, an article entitled, For Black Americans, financial damage from subprime implosion is likely to last, “The implosion of the subprime lending market has left a scar on the finances of [black] Americans—one that has not only wiped out a generation of economic progress but could leave them at a financial disadvantage for decades,” Prof. Sessen cites 2006 statistics for New York City, noting the percent share of foreclosures, among Black New Yorkers, reached an alarming 40.7%, Hispanics 28.6%, Asians 13.60% and Whites 9.10%. The NAACP and the National Urban League have argued that the nation’s financial crisis has “ushered in a new era of de facto economic segregation.”

San Bernardino County’s woes are the nation’s woes. The county’s progress in implementing its new eminent domain program for underwater mortgages will be watched closely. If fully implemented, the program’s future will surely rest with the courts, as constitutional issues have been raised by the opposition and must be adjudicated. San Bernardino county will face a vigorous battle from the banks, stiff legal fees and a well funded campaign to “stop the expropriators.” The alarming level of expulsions (foreclosures) and underwater mortgages leaves this county and its cities no choice but to seek a new path for resolving this existential crisis of the American Dream.

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