If you live in Silicon Valley and want to go to Napa wine country for the weekend, I suggest you avoid driving through Richmond, Calif. Richmond city officials might decide that local residents need nicer cars, and therefore they may seize your vehicle under the power of eminent domain, offering to pay you what they think your car ought to be worth.
Ridiculous? Sure. But it’s only a mild exaggeration of what’s actually happening in Richmond.
Richmond has asserted the power to buy 626 current and delinquent mortgages on homes occupied by its residents, using the city’s power of eminent domain. The city will pay what it considers fair market value based on what the home in question is currently worth. None of the homes in this initial batch of offers have large second mortgages, in part so the city can avoid accusations of making lenders take a haircut to help irresponsible homeowners who “used their homes as A.T.M.s,” according to The New York Times.
Investors all over the country - in fact, all over the world - will be startled to learn that officials in a medium-sized California community think they have the power to rewrite the terms of debts that their constituents accrued. Most likely, though not certainly, they don’t actually have that power. That has not stopped them from trying to exercise it anyway.
Mortgages are classified as “intangible property.” Unlike real estate or tangible personal property, such as cars or other possessions, it’s not obvious where intangible property is located. Generally, intangible property is considered to be located at the owner’s domicile, but this can vary widely depending on the specific circumstances. Richmond is arguing that if mortgages are secured by homes within the city, then the mortgages themselves are subject to Richmond’s eminent domain power.
That legal stretch is bound to be tested in court if Richmond proceeds with its plan. While the city clearly has the power to seize the actual homes within its boundaries, this would not accomplish the city’s goal of erasing underwater mortgages. The homes would remain subject to lien.
Mortgage Resolution Partners, a private company based in San Francisco, cooked up the idea of Richmond seizing mortgages instead. MRP has proposed the plan in other jurisdictions too, including Vallejo, Calif., and North Las Vegas, Nev.
Besides the question of whether intangible mortgages are even within the geographic scope of local eminent domain powers, another problem would be valuation. In the Times article discussing Richmond’s plans, an example suggests that a $400,000 mortgage on a home that is now worth $200,000 could be purchased for $160,000. The discount is based on the assumption that the risk of default lessens the value of the mortgage. Investors putting up the money to buy the loan will receive an immediate profit when the homeowners refinance for more than the city paid. If the home could support the $190,000 mortgage the article suggests, however, then the fair market value for the original mortgage should not be less than that. The plan’s economics just do not make sense.
But politicians are not economists, and it’s the politics of the plan that is more likely to motivate politicians’ actions. Richmond’s mayor, Gayle McLaughlin, is a member of the Green Party. In fact, Richmond was the first U.S. city of over 100,000 residents to have a Green mayor, and remains the largest metro area with one to date. Based on the political affiliations and actions of its leadership, Richmond’s political class clearly has no objection to redistributing wealth. The concept may not be offensive to many of the city’s residents, either; McLaughlin was elected with the support of the Richmond Progressive Alliance, a political group she co-founded and which remains active.
But in the unlikely case that Richmond’s gambit to rewrite the terms of residents’ mortgages succeeds, the consequences won’t be restricted to the city limits. If Richmond seizes these mortgages, lending will be chilled throughout the state of California, whose laws will necessarily be construed as allowing the practice. While Richmond cannot use eminent domain against federally held debt, arguably including mortgages held by Fannie Mae or Freddie Mac, Richmond (along with any other city in California) would have the theoretical power to seize private mortgage loans as it saw fit. Lenders would have little incentive to be generous with Californians.
And why stop there? If Richmond’s attempt works, what is to stop cities from seizing their residents’ credit card debt at discounted values, and then either collecting a profit as residents pay up or passing the savings to local voters?
All this raises the question: Why would any bank issue unsecured loans to Richmond residents in a world where the city could simply let residents out of their obligations for dimes on the dollar if necessary?
To prevent their voters from losing any chance of securing future loans, Richmond’s officials intend to reach into the community activist toolkit and invoke federal laws such as the Community Reinvention Act. They plan to argue that banks are obligated to lend money, even imprudently, to Richmond residents lest they be accused of discriminating against the poor or unemployed. U.S. Rep. John Campbell, R-Calif., has already been accused of redlining, which is the illegal practice of discriminating against a geographical area based on its racial or ethnic makeup. His so-called offense, however, was simply introducing a bill that would prohibit Fannie Mae or Freddie Mac from making or guaranteeing mortgages in communities that have used eminent domain the way Richmond wants to.
If lenders refuse to make loans to Richmond residents, it would not be redlining, despite the eminent domain supporters’ obnoxious comparison. Any “discrimination,” such as it is in this case, would be based on the politics of the city’s leaders, not on the racial composition of the city’s population. But by readying such accusations, Richmond officials hope to spare residents the predictable consequences of the city’s money grab.