
Richmond’s rules: Why one California town is keeping Wall Street up at night - MaysonL
http://www.washingtonpost.com/blogs/wonkblog/wp/2013/10/05/richmonds-rules-why-one-california-town-is-keeping-wall-street-up-at-night/
======
josephagoss
They say using Eminent domain as if thats the solution, take the banks
property away.

I am thinking the fallout from this move will be disastrous. These are the
ideas that fundamentally change the fabric of a society. Now the Government
will use Eminent domain whenever a private entity is acting against the social
interests of the citizens, whilst many will applaud such a move I fear it
gives the Government and elected officials far too much power.

Also why bother obtaining property and wealth when the Government positions
itself as the taker of all things whenever it suits them best?

~~~
nl
_Now the Government will use Eminent domain whenever a private entity is
acting against the social interests of the citizens, whilst many will applaud
such a move I fear it gives the Government and elected officials far too much
power._

Isn't the purpose of government to protect its citizens when a more powerful
entity acts against them?

 _Also why bother obtaining property and wealth when the Government positions
itself as the taker of all things whenever it suits them best?_

I agree. That's clearly _not_ what is happening here, though.

For one thing, the people who have taken the mortgage out own at least some of
the property, and secondly the banks that hold the mortgages are profiting
form fraud (ie, the deliberate strategy of selling sub-prime mortgages to
people who couldn't afford them). Finally, this isn't _what suits [the
government] best_. It would suit the local government if the problem could be
ignored, which is what other jurisdictions (including at the Federal level)
are doing.

~~~
JumpCrisscross
" _the people who have taken the mortgage out own at least some of the
property_ "

By definition of being underwater they own no equity of value. When a company
goes bankrupt, i.e. when a company's equity value hits zero, i.e. when a
company's assets are worth less than its liabilities, shareholders are wiped
out. At that point they have no residual claim to the assets.

~~~
nl
Yeah, but that's an outcome of the way US mortgage system works (ie, the
mortgage holder is preferred over other equity holders).

It doesn't have to be this way; for example in the event of a liquidation
_all_ parties with an equity interest could have money distributed to them in
proportion to the interest the hold.

------
ig1
They're making the fundamental mistake of fixing a problem now in a way that
will cause huge problems in the future.

Mortgage lenders will put huge premiums on mortgages in the town in the future
because of "default by eminent domain" risk, if the government pulls
freddie/fannie mae it'll be even more expensive. Basically they're robbing
future mortgage owners in order to pay current ones.

Worse yet, other towns with similar profiles might have their risk profile
increased too, so they'll get extra premiums because of Richmond's behaviour
without getting any of the benefits.

So while it might seem like they're just taking the money from pension funds
and other investors, in the longer term they'll be taking far more from future
mortgage owners.

~~~
tmorton
If this system becomes routine, mortgage rates will go up, though I'm not sure
about "huge premiums."

Is that a bad thing? The investment becomes risker and more expensive, so less
money is available, so fewer mortgages are made. More people rent instead of
buy their own homes. I would submit that fewer owner-occupied homes would be a
positive thing for the national economy.

~~~
different-opini
Fewer mortgages = lower property prices.

No mortgages = 10x lower property prices.

~~~
ams6110
No mortgages = Detroit. The end result of this idea is not pretty.

~~~
tanzam75
> _No mortgages = Detroit. The end result of this idea is not pretty._

The lack of mortgages did not cause the collapse of Detroit. The causation
runs the other way.

The collapse of the auto industry led to the collapse of housing prices in
Detroit, which in turn led to the collapse of the mortgage market. Who wants
to issue mortgages for houses that are dropping in value?

------
JumpCrisscross
Richmond has decided to tear up a private contract to one side's advantage
based on no pre-existing law. This is, generally, contrary to the principles
of rule of law. The upside will be a short-term bump in Richmond's residents'
balance sheets.

Courts are likely to strike this down. This will trash Richmond's public
balance sheet. If courts allow this one would eventually expect private sector
credit availability, to anyone in a low income neighbourhood, to dramatically
re-price or freeze. It could also trigger a national housing credit, and
price, pull-back.

Ironically either outcome will further impair Richmond property values,
pushing more borrowers underwater and the city's tax income lower.

~~~
toomuchtodo
You're right. You know what would be easier? For all of Richmond to default on
their mortgages.

Sidetrack: I put $50K into a townhouse in 2007 (my mistake!). I lost it all
when the real estate market flopped. I walked away from the property because I
wasn't willing to work for several years just to pay the principle down.

End result: No matter what, the real estate lost value. Either write it down
now, or enjoy the pain as you write it off later (ie "extend and pretend":
[http://www.americanbanker.com/bankthink/megabanks-extend-
and...](http://www.americanbanker.com/bankthink/megabanks-extend-and-pretend-
they-will-never-pay-for-foreclosure-fouls-1052937-1.html)).

What's that? Default judgement? Oh no. Bankruptcy. I still get to keep $1MM
plus in retirement accounts, and I just can't buy another house for ~7 years.
How horrible.

~~~
JumpCrisscross
Couldn't agree more - default is the proper way to do this. Others include
Richmond (a) buying underwater mortgages off investors and tearing them up or
(b) making mortgage payments for its residents (an ersatz bail-out to
investors).

~~~
toomuchtodo
Agree. But! You're going to need to find a way to untangle which investor owns
which mortgage (these are derivatives after all). I'd say you get 90 days as
an investor to respond; after that, the city gets to take unilateral action.

~~~
JumpCrisscross
" _But! You 're going to need to find a way to untangle which investor owns
which mortgage (these are derivatives after all)._"

Mortgages are not derivatives, they are debts. Tracing the owner of a mortgage
should not be challenging. In the event that it is, that becomes the mortgage
servicer's fault, an issue between the investor and the servicer.

------
tomohawk
The US constitution says:

"No State shall enter into any Treaty, Alliance, or Confederation; grant
Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any
Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of
Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or
grant any Title of Nobility."

~~~
venomsnake
And since when Richmond is a state? You can read the constitution by spirit or
by the letter. You cannot have both.

~~~
tanzam75
> _And since when Richmond is a state? You can read the constitution by spirit
> or by the letter. You cannot have both._

There is no local sovereignty in the United States, except for whatever a
state chooses to delegate to its municipalities. (This is why you hear about
states that take over failing cities' schools and finances. The city possesses
no sovereignty.)

All of Richmond's powers derive from the State of California. If California is
prohibited from doing something, then so is Richmond.

------
millstone
If a mortgage is underwater and the debtor cannot (or will not) pay, then it
hardly matters to the investors whether the owner is foreclosed on, or the
city forces principal reduction. Either way, the investor takes a loss. But
seizing _current_ underwater mortgages would be terribly shortsighted.

What intrigued me is the idea that investors would be willing to accept a
principal reduction, but cannot because the logistics are too difficult. FTA:

 _Although it was in the banks ' interest to write down the principal on loans
to avoid an outright default... ...so many different investors would have to
sign off on the change. Because of that, these "private label securitized"
loans are much more likely to default than the banks' portfolio loans._

So maybe a deal could be crafted that is in the interests of both investors
and homeowners. Home buyers might get the short end, with fewer foreclosed
homes coming on the market, but I've heard that banks tend to sit on
foreclosed properties for a long time anyways, so it may not affect the market
supply much.

~~~
JumpCrisscross
" _If a mortgage is underwater and the debtor cannot (or will not) pay, then
it hardly matters to the investors whether the owner is foreclosed on, or the
city forces principal reduction. Either way, the investor takes a loss._ "

Mortgage markets are not terribly liquid. The "market value" the City of
Richmond picks may not be favorable to the investor. The extra-contractual
origin of this market-value-by-fiat makes it doubly uncomfortable.

Further, collateral can improve in value. The housing market is presently
appreciating. A defaulting debtor's prospects are less certain.

------
Lazare
The reporting is frankly terrible.

Let me put it in simple terms. An idea has been floating around for a while
now that, in theory, you could use eminent domain to seize not just the
houses, but the mortgages _on_ the houses. Let's say that someone had borrowed
$200k, but the house was now worth $100k. If you were a local government, you
could seize the mortgage from the mortgage holder paying them compensation of,
oh, $80k, tear it up, then the home owner gets a new mortgage for $90k, and
gives you the proceeds, which would pay you back for the compensation you had
to give the mortgage holder, _and_ leave you with $10k to cover your
overheads, fees, court costs, and maybe even leave something over for the
group of highly altruistic bankers pushing this scheme.

This is normally where I would say "but there's just one problem", but that
would be a lie, because there's at least three.

1) The constitution, post _Kelo_ , is pretty lax about needing a good reason
to deploy eminent domain, but it's still quite strict about the compensation
needing to be fair (ie, the market value). The market value of a $200k
mortgage for a $100k house is __NOT __$80k, or even $100k. Even if the
mortgage is currently in default, it still represents ownership of a house
worth $100k; by definition that makes it worth $100k, no $80k...and many
mortgages won 't default at all; even the ones who will eventually will be
making payments in the meantime. So right off the bat, legal analysts are
confident it's unconstitutional. (But the city can't offer the actual market
value of the loan; they're broke.)

2) Banks are going to be very displeased. Except that's a lie; in the US banks
don't actually make mortgages. The Federal government does (more than 90%, in
point of fact), through the FHA. And they have already stated that they think
this is the worst idea since forever, and they will take whatever steps
necessary to shut it down, including just not making any more loans for houses
in the region. Which in context is basically the nuclear option; the value of
a house which can't get a mortgage is pretty much $0. The scheme absolutely
relies on being able to get a new mortgage on the houses.

3) Just as if that wasn't enough, the IRS has a lot of very strict rules
involving gifts. And buying someone's loan and tearing it up counts as a gift,
and you have to pay tax on it. Quite a _lot_ of tax, as it happens. And the
homeowners in question don't have the cash, nor would they be thrilled at
their massive tax bills even if they did. Which, again, kills the scheme.

4) It's also not entirely clear that this would be good policy even if it
worked. This isn't the first attempt at trying to "fix" the problem of
underwater mortgages, but results so far have been mixed at best. Then there's
the broader policy implications of a bailout. Once you crunch through the
likely results of the program, it's not exactly "take from the banks and give
to the poor". The banks don't actually _own_ mortgages, and the poor don't
actually own houses. It actually ends up being "take from the pension funds
and split the results between the middle class and some bankers". Makes for
great soundbites, but it's not exactly Robin Hood and Sherwood Forest here.
More like the Sheriff of Nottingham.

TL;DR: The plan is illegal, the federal government has already announced that
they're putting a stop to it (and they hold _all_ the cards in the mortgage
market), it wouldn't work anyhow, and it's probably bad policy even if it did.
It's been called a "scam", and frankly, that's pretty accurate.

Edit: From the article: "He's actually the guy responsible for it all: Steven
Gluckstern, a former insurance executive who had teamed up with Vlahoplus to
co-found Mortgage Resolution Partners, the firm that's lining up the capital
-- from hedge funds, for instance -- to buy any mortgages that Richmond might
seize. After that happens, Mortgage Resolution Partners would help the
homeowner refinance through a Federal Housing Administration loan, and earns a
$4,500 fee per successful transaction." Keep in mind that the FHA has said
they won't make the loans. The scheme, at its core, is for some bankers to use
hedge fund money to grab assets from pension funds, then refinance it using
super-cheap loans from the FHA to turn a quick buck. But the FHA has stated it
won't make the loans, so the scheme is D-E-A-D dead.

~~~
_delirium
I don't think the plan will work either (for many of the reasons you've
given), but I'm not as sure about this one:

 _The market value of a $200k mortgage for a $100k house is NOT $80k, or even
$100k. Even if the mortgage is currently in default, it still represents
ownership of a house worth $100k; by definition that makes it worth $100k, no
$80k..._

The market value of the mortgage is whatever it would actually sell for on the
open market. I don't see a strong reason to believe it would always be equal
to the price the underlying asset would sell for. Sometimes owning the
mortgage is more valuable than the underlying property, because you've locked
in a good interest rate and cash stream. Other times it's less valuable,
because you have potential hassles over eviction, damage, etc., or because
you've locked in a bad interest rate (the latter being the same reason bonds
can be worth less than their face value).

In a situation like Richmond's housing market, with high default rates, it
wouldn't be too surprising that an unencumbered property could sell for more
than a mortgage on the same property would sell for. If _I_ were buying, I
would certainly demand a discount on the property to compensate for the risks
of taking over the mortgage and a house with a resident in it, versus the
situation of buying the property completely free and clear. That's not even
specific to mortgages; any asset with a contract attached to it will be valued
by taking into account the contract.

~~~
jamesaguilar
It's an interesting hypothetical, but presumably there is data about how much
mortgages are worth along all these axes, since they are traded fairly
heavily. We don't need to guess about it.

~~~
ChuckMcM
The challenge here is that the mortgage has a different valuing scheme than
the property. The mortgage is valued against the rate of return and the risk
of default. The property is valued against comparable properties.

The whole problem here is that you might have a $200K mortgage which is
written to a very credit worthy borrower who is paying on time, against a
house with a market value of $100K (probably not in the Bay Area but this is
just an example).

So the fair market value of a $200K mortgage, that matures in 2033 might be
$100k (this is essentially a zero coupon bond at this point and we're assuming
a 3.5% rate of return) could be "destroyed" (which is to say seized by eminent
domain) and replaced with a $100K mortgage that matures in 2043 (assuming a 30
yr mortgage). That is worth something like $35,000 (again assuming an annual
rate of 3.5%) which quite a bit less than $100K,

So looking at it as an investor you've had $100K worth of "principal" stolen
from your retirement account by the City of Richmond, and sold to someone else
for basically 1/3 the price, because the underlying basis for this particular
investment vehicle was someones home, which is now underwater value wise.

The saddest part of the mortgage mess is that it is so freakishly complicated
to figure out what or who owns a mortgage in the world of derivatives. If
Richmond is successful (and I hope they are) the next story will be people who
have this sudden drop in their 401k investment value with a note "Funds taken
by City of Richmond" ) and those folks are going to go "WTF?" and the next
round of scare stories will be "Richmond just yanked nearly a billion dollars
out of people 401k funds and gave them to a Hedge fund, could you be next?"
And nobody will be calling for the real reform which is some level of
regulation on what you can and cannot do with a home mortgage security.

------
ars
Good luck to anyone ever getting a mortgage in that town ever again.

~~~
dmk23
Moreover, the property values there will go even lower because of dried up
financing.

This could become a textbook case of government power abuse backfiring at the
people the politicians claim to be "helping"

There is a better description of what this city did: Theft

~~~
zero_intp
While I agree with railing about bad decisions, it is almost willfully
ignorant to continue to argue against settled law. This is as much theft as it
was in Connecticut.

As much as I hate it, "Wickard vs Fillburn", and "Citizens United v. Federal
Election Commission", "Gonzales v. Raich", and lastly "Kelo v. City of New
London" ARE the laws of the land.

If the investment classes are going to be leveraging laws against homeowner to
take property at 'current market prices'; how is it wrong for cities to force
investor classes to do the same?

Change the laws, but don't decry the victims of fraud and systemic false
market inflation turning the current laws against those who perpetuated the
pump and dump scheme on them in the first place.

I think it will cost some financing issues/property costs, but then it will
lead to the rise of a Community Trust bank or Credit Union. These are things
that truly change communities.

------
thrownaway2424
Hacker News cognitive dissonance week:

    
    
      1) Creating technical arguments against court-ordered search warrants: heroic civil disobedience.
      2) Creating technical workarounds for mortgage debt paralysis: craven violation of sacred property rights.

~~~
mikeash
Can you elaborate as to exactly why a person who does not have the same
opinion on both 1 and 2 must be suffering from "cognitive dissonance"? I don't
see much of a relation between them.

~~~
asdfologist
Because he's still offended by the massive downvotes on his illogical
comments:

[https://news.ycombinator.com/item?id=6485956](https://news.ycombinator.com/item?id=6485956)

~~~
thrownaway2424
Yes, because I personally give a shit about your stupid downvotes. I am
devastated.

------
cynicalkane
The reporting of the so-called "Wonkblog"'s reporting is particularly un-
wonkish, describing the plan as 'complex' and talking about it in one of those
artificial newspaper pseudo-neutral points of view, affecting to be balanced
while dropping loaded language like such as

 _A courtroom victory for Richmond, a town of about 100,000, could give cities
around the country the courage to act -- and potentially help keep millions of
people in their homes._

The plan doesn't target distressed mortgages, so it's not just a problem of
loaded language designed to appeal to certain kinds of readers--it's also a
bald lie. As for the other side:

 _But even a win could spell defeat for Richmond if the financial industry
cuts off lending to make an example of the city._

Make an _example_ of the city. Hmm. It's not that private industry is not
obligated to do money-losing business with eminent domain thieves, it's that
they want to make an _example_ of people who cross them. Well, you can see
what the writer actually believes, or at least what he pretends to believe in
order to appeal to readers.

The plan is not 'complex' but fairly straightforward and very obviously
illegal and not in the best interests of the public. I'm not aware of any
informed opinion to the effect that this is a good idea. I discussed this in
an earlier
post([https://news.ycombinator.com/item?id=6273836](https://news.ycombinator.com/item?id=6273836)),
which I think is worth reposting, because as far as I can tell little has
changed since then.

Repost below:

====

The blog Naked Capitalism--hardly a friend of big finance--points out that
this is a scam here: [http://www.nakedcapitalism.com/2013/08/beware-of-
private-equ...](http://www.nakedcapitalism.com/2013/08/beware-of-private-
equ..).

Some key points:

* The profits are being split among Richmond and a private investment firm named "Mortgage Resolution Partners, LLC".

* Seizing a mortgage for less than its fair market value is blatantly unconstitutional. The argument that the value of an underwater mortgage in repayment is worth less than the house is so obviously wrong, I have a hard time believing Richmond officials honestly buy it. A mortgage that is on track to be repaid is undoubtedly worth close to the future value of repayment, even if the house is worth $0.

* Big banks do not actually own most mortgages in general. So this is not a scheme to rob big banks, although Mortgage Resolution Partners, LLC certainly wants to spin it that way.

* Almost all housing mortgages are merely serviced by banks but owned predominantly by entites such as "state and local governments, hospitals, Fannie, Freddie, and to a lesser degree, foundations and endowments". The banks have a legal obligation to protect these mortgages, of course.

* Many of these loans are current--they're not distressed mortgages at all! They also plan to steer clear of houses with liens. Naked Capitalism comments that the plan only works financially if they go after the mortgages of those that need help the least.

In short, this is a transfer of wealth from a diverse array of investors to
the city of Richmond and a bunch of investment banker types--theft under the
cover of populist outrage. It would also severely damage the market for future
homeowners in Richmond, anyone who wants to sell their home, anyone who wants
to refinance... Oh, it's also a threat to fundemental notions of private
property, rule of law, and market capitalism, but distressingly few people
still care about that. The bit I want to emphasize is that it's Prince John
pretending to be Robin Hood.

~~~
zero_intp
Factually you are absolutely correct. But bad outcomes like this are the
result of bad decisions by the Supreme Court. We all have to live in a land
run by "Kelo v. City of New London"

Maybe this can help get the laws under that decision changed.

~~~
cynicalkane
The eminent domain plan simply lies about the value of a mortgage, saying it's
worth less than not only best accounting practice but the market value
required for their plan to work. _Kelo_ doesn't apply because using a clearly
unfair valuation in eminent domain is directly against the Constitution.

~~~
jbooth
I don't disagree, but the definition of "clearly unfair" floats on the whims
of Justice Kennedy.

~~~
cynicalkane
Only a small fraction of constitutional disputes end in a 5-4 decision, and
the ideological divides in those opinions are narrower than op-ed writers
would have you believe.

------
enko
While I am pretty sympathetic to the anti-TPP cause, the video is _awful_. It
started off with ridiculous scaremongering about "frankenfoods", ie GMO foods,
which have the potential for incredible benefits for mankind. It even
specifically calls out food grown in a lab - do these people not realise the
environmental damage we could prevent if we could grow meat? The nutritional
benefits? The cruelty averted?

And that's the very first thing they said! I couldn't tell you the second
thing, because I closed the video.

What is it about these activist organisations that compel them to so
consistently throw the baby out with the bathwater?

~~~
justincormack
Thats a different story!

------
tytso
It's not necessarily a fraud. The key is it only works in cases where the fair
market value of the house is below the value of the mortgage. In that case,
the city only has to pay the FMV. Now, there is always going to be some
question about what is actually the FMV of a property. But this is true
regardless of whether the city is in cahoots with a property developer who
wants to put up some expensive shopping mall where single family homes once
stood, or in this case where Richmond is proposing to seize by eminent domain
houses which are underwater.

Why are the banks against this? (1) they believe they could get more at
auction than the FMV determined by the eminent domain process, and (2) the
seizure happens at a time outside of their control, where as the bank might be
holding off on the foreclosure process since if they were to actually
foreclose on the property, and discover from the auction that they could
recover significantly less than the mortgage, they would then realize a loss
which would screw up their capital holdings.

Either way, as far as the homeowners are concerned, they are effectively going
to be foreclosed against. The only difference is that they will be offered a
chance to continue to live in the house, and pay rent (which might or might
not be at FMV; it's not clear from the description). Maybe it might be a rent
with an option to buy, but basically the main goal of the city is to preserve
the neighborhood instead of letting speculators buy the house at foreclosure.

So I wouldn't necessarily call it a scam. Will the banks lose out? Probably.
But I don't know that they would necessarily lose out that badly --- that is,
unless you don't believe that people who lose their houses due to eminent
domain when a city is enriching some real estate developer isn't paying FMV to
people who are turned out of their homes to build a shopping mall or a new
stadium....

------
negamax
It's the money of other citizens. People don't realize it but money doesn't
always gets invested from wealthy individuals. It could very well be from
pension funds, mutual funds etc. So it's not that banks are getting hurt but
other normal citizens. Also, stop painting banks as evil.

~~~
nl
_It 's the money of other citizens. People don't realize it but money doesn't
always gets invested from wealthy individuals. It could very well be from
pension funds, mutual funds etc._

Pension & mutual funds are big enough to force banks to act differently, and
haven't. They should bear the risks associated with that behaviour.

 _stop painting banks as evil_

Why? Their behaviour in the lead up to the 2008 financial crisis was unethical
(to say the least), and their behaviour after 2008 has shown a complete lack
of regret.

