California Proposes Crony Capitalism to Fix Housing Crisis

Government officials want to use eminent domain to acquire mortgages.

The real-estate market is reviving so quickly that talk of the busted housing bubble is passé. These days, when real estate investors talk about bubbles, they are referring to the new one that might now be inflating as home sellers sift through a frenzy of offers.

Even cities that bore the brunt of the foreclosure crisis are seeing massive price jumps and many homeowners who were "under water" in their mortgages can start talking "home equity" again.

Yet some government officials seem to live in a time warp as they pursue a murky deal to "solve" the dissipating housing crisis by marrying government power with private enrichment. The California city of Richmond is the first one to sign on to an idea that lenders fear could sweep the state.

City officials would use eminent domain — i.e., the power to take property by force, upon the payment of "fair compensation" to the owner — to wrest control of hundreds of mortgages held by private-equity firms. They're not taking the actual property, mind you, but grabbing the notes held by those who financed the homes.

Advocates see it as a way to halt foreclosures, but foreclosures are working their way out of the system — so much so that first-time home buyers struggle to compete with cash-paying investment groups that are grabbing these properties.

"It's the most abusive thing I've seen in a long time," said U.S. Rep. John Campbell, an Orange County Republican who is sponsoring federal legislation to quash such efforts. The concept, he told me, is driven by a San Francisco firm called Mortgage Resolution Partners, which stands to profit financially from this process it has pitched to cities.

Let's say you owe $300,000 on your home and it is currently valued at $200,000. The city takes the mortgage from your lender and pays it the estimated value, minus about 20 percent. Your lender gets $160,000. The new investors refinance the property based on the non-discounted value of $200,000 — and you, the homeowner, get to stay in the house and make payments on the new, lower principle. These new players, consultants and the city profit from the proceeds, which comes from the difference between the price they pay and the higher price at which they refinance the loan.

Campbell is livid that the deal is financed on the backs of taxpayers given that the loans will be sold back to Fannie Mae, Freddie Mac and FHA. He and many others also are opposed to what they rightly view as a misuse of power.

"One group of investors, MRP, has figured out a way to use the legal powers of municipalities to extract profits from the people who hold Mortgage Backed Securities," Chris Killian, an executive with the Securities Industry and Financial Markets Association, told me. The plan will add risk and costs to investors, he said, which will reduce the pool of buyers willing to take a chance in the city.

Lt. Gov. Gavin Newsom, a vocal supporter of the MRP plan, called for a federal investigation of lenders who have opposed it. He argues that they may be colluding to discriminate against these cities. But his statements only remind critics of how much this plan is dependent on political wrangling rather than market forces. MRP is run by a prominent Democratic Party fund-raiser.

"Newsom has no concept of how investments work," Rep. Campbell said, noting that people don't lend money if they know it's going to be seized.

It strikes me as the ultimate "crony capitalist" project where a private organization uses government power to secure a lucrative deal that would never pass muster in the marketplace, where buyers cannot compel owners to sell at a low-ball price.

Cities will face lawsuits challenging these takings. Even if the courts allow it, it will take time to sort through the complexities given the complex ownership structures of many real-estate investments. This process could take years, even as the real-estate market rebounds each month.

Nevertheless, Richmond sent a letter July 31 warning mortgage trustees that the city might proceed with eminent domain if they don't sell the mortgages. MRP did not respond to a request for comment, but its officials talk about the devastation of a foreclosure crisis as if it's still 2006, right after the bust.

Online real-estate sites show that Richmond's property values have increased more than 20 percent in the last year and are expected to increase another 10 percent this year. Here's a case where doing nothing sounds like a far better approach.