Mortgage Investors Protest as California Localities Weigh Seizing Loans

By Kate Berry

JUL 6, 2012 11:51am ET

Three California local governments may use their eminent domain powers to seize mortgages and restructure them to help distressed borrowers stay in their homes – much to the dismay of investors who hold the mortgages.

Eighteen trade groups, including the American Bankers Association, the Securities Industry and Financial Markets Association and the Housing Policy Council of the Financial Services Roundtable, have called into question the legality of a plan proposed by a venture capital firm and being considered by three California municipalities. The program would allow the governments to use their eminent domain powers to seize loans held in private-label mortgage-backed securities.

“We believe that the contemplated use of eminent domain raises very serious legal and constitutional issues,” the trade groups said in a letter late last month to California’s San Bernardino County and two of its city governments, Fontana and Ontario.

But those protests may be premature. After the San Bernardino County program was highlighted in a front-page Wall Street Journal article, a spokesman said the county is not sold on the idea.

“We see it as intriguing, but it’s definitely not something we’ve decided to do,” says San Bernardino spokesman David Wert. “We just wanted to get all the information and see if it might actually work. We fully expect the banking, mortgage, real estate and investment communities to show up and tell us what they think.”

The San Bernardino County board of supervisors last month unanimously allowed the municipalities to form a Joint Powers Authority to consider the idea, and Wert says the county may hold public hearings as early as next week. The plan would restructure mortgages with negative equity, in which the homeowner owes more than the home’s current market value.

The program is the brainchild of Mortgage Resolution Partners, a San Francisco venture capital firm headed by Steven Gluckstern, the chairman and CEO of Ivivi Health Sciences and former CEO of Zurich Reinsurance and Centre Reinsurance.

The venture capital firm has hired investment banks Evercore Partners and Westwood Capital to raise funds from private investors that would be used by the San Bernardino County government to purchase the loans. The municipalities could then modify or restructure the loans.

A spokesperson for Mortgage Resolution Partners declined to comment and referred queries to San Bernardino.

Wert says that executives from the venture capital firm came to the county with the idea because Gregory C. Devereaux, San Bernardino’s chief executive, is regarded as an expert on local government housing issues. But Devereaux was not comfortable having discussions “behind closed doors,” Wert says.

“One of the things that has to be looked at is whether this would be the right thing to do or if it could cause more problems than it would solve,” Wert says. “We aren’t sold on it yet. It looks intriguing and if it actually works it could benefit tens of thousands of families.”

The mortgage investor groups claim that seizing homes through eminent domain could result in “significant harm” to homeowners, by reducing access to credit for future borrowers and potentially dragging down home prices. Doing so would undermine “the sanctity of the contractual relationship between a borrower and creditor, and similarly [undermine] existing securitization transactions,” the groups said in letters to the municipalities.

“It’s quite clear to us that there are a lot of questions about the legality of this,” says Chris Killian, a managing director at Sifma. “Is it legal for a county to use eminent domain for mortgage loans? When you exercise eminent domain, you have to compensate the person you’re taking the properties from and how that compensation is defined is an important question.”

The plan has the backing of Yale University economist Robert Shiller, who wrote in an Op-Ed in the New York Times last month that the troubled real estate market represents a “collective action problem.”

“In a nutshell, mortgage lenders need to write down the amounts owed by individual homeowners .but the different stakeholders have been unable to reach an agreement even if it is in their common interest,” Shiller wrote.

San Bernardino has roughly 150,000 underwater mortgages.