(MoneyWatch) A California city has come up with an unusual way to keep its residents out of foreclosure: Take over their mortgages.
Richmond, Calif., launched a local principal reduction plan, a controversial program that would allow the city to purchase underwater mortgages. Failing that, the city will use eminent domain to purchase the loans. Then the city would refinance or modify their mortgages to reduce the principal to a level more in line with current market values throughout the struggling city.
The city has partnered with Mortgage Resolution Partners (MRP), an advisory firm that has lined up the funding to purchase the loans and technical support to carry out the program. The company has promised the program won't cost taxpayers a dime, and homeowners who opt in to the program will pay a flat $4,500 fee.
City officials are hoping the unusual plan will save Richmond from its desperate situation. Home prices have plummeted 43 percent since their 2007 peak, leaving half the homeowners with mortgages in the city underwater. The city's coffers have suffered, too, due to the steep reduction in property taxes paid, and it has slashed its budget repeatedly, making it harder to keep up with road repairs, offer basic services and combat the uptick in crime.
Richmond is offering the program to 624 homeowners whose loans are underwater and highly likely to fall into foreclosure, according to Graham Williams, CEO of MRP. Only 180 are delinquent, while 444 are still current on payments.
Most of those mortgages were taken out by low-income, minority residents who were the victims of predatory, subprime lenders, city officials and housing advocates say.
"These are not, for the most part, fixed-rate loans," Williams said. "They are negatively amortizing, low-doc and interest-only loans."
Even if homeowners are current, they are still highly likely to default at some point in the future, according to an analysis conducted by MRP.
Morris LeGrande, a homeowner pushing for the program in Richmond, is underwater by $300,000 on a home currently valued at just $130,000. Yet he is paying close to $3,000 a month and has a jumbo payment of $190,000 due in 27 years.
"I am not a homeowner under a technical definition," he said. "I will never be able to pay for this home under the current conditions."
His loan originated with a bank but was bundled and sold and is still currently being moved around from servicer to servicer, he said.
LeGrande's story is similar to others in the community whose loans were sold to pools of private investors and are dubbed private-label security mortgages. The investors who own these loans claim they cannot be modified.
"After years of waiting on the banks to offer a more comprehensive fix or the federal government to make them, we're stepping into the void and making it happen ourselves," Richmond Mayor Gayle McLaughlin said.
The city will first attempt to buy the mortgages from the companies but will move to seize the properties through eminent domain if the two parties don't agree on a fair price.
And it's the potential use of eminent domain that is riling up the mortgage banking industry. The Mortgage Bankers Association paints a dire picture if the eminent domain plan isn't dismantled.
"Using eminent domain to seize mortgages will result in tighter, more expensive credit for potential home buyers and those looking to refinance, driving down home values and threatening local economic recovery," said MBA president and CEO David H. Stevens in an e-mail. "Further, cramming losses down on existing mortgage-backed securities holders will drive down the value of millions of Americans' investments, including pension plans, mutual funds and 401(k) retirement accounts."
So far, a coalition of financial organizations has quashed previous attempts at using eminent domain to seize mortgages. Last year San Bernardino County, east of Los Angeles, attempted the same idea with Mortgage Resolution Partners. After initially gaining momentum, the plan quickly fell apart when industry opponents launched a massive campaign to fight the proposal. Under threats of expensive and lengthy litigation, and without enough public support, San Bernardino dropped the idea.
But this time around, MRP has agreed to pay for any litigation costs on behalf of Richmond.
Legally speaking, however, experts are questioning whether the opposition really has a leg to stand on.
"I think the fact that the mortgage industry is going kind of nutso on this demonstrates they're not so confident on their legal claim," said Tim Iglesias, professor of law at nearby University of San Francisco School of Law.
There's conflicting views on eminent domain, but under current interpretations of the constitution, Richmond likely does have the right to seize the homes, he said.
"The real legal issue is going to be about public use and public purpose," Iglesias said.
Generally, the government can seize a home through eminent domain when it serves a public purpose. That public purpose ranges from curing blight to building a road to creating economic development, at least in California.
"I think the city of Richmond has a lot of really strong arguments," Iglesias said. "More than half its homes are underwater, so they can cite health and safety purposes and could make the economic development argument to rescue the city from going under."
Still, opponents claim this particular use of eminent domain is both illegal and unconstitutional and may still bring legal action against the city to stop the plan in its tracks.
In the meantime, Richmond will move forward under close watch by several other cities. The California cities of El Monte and La Puente are advancing their programs, and North Las Vegas is looking into it.