Richmond, Calif. Eminent Domain Proponents, Critics: Q&A

Proponents of a plan in Richmond, Calif. to purchase foreclosed homes using the legal process of eminent domain - the power of the government to seize private property for public use - say critics are grasping at straws to stop the proposal.

Graham Williams, CEO of Mortgage Resolution Partners, a firm in San Francisco advising the mayor of Richmond, said, "Opponents are raising false issues."

Gayle McLaughlin, mayor of the City of Richmond, said, "We call on these banks to do the right thing and sell us the loans at fair market value, so that we can do what they have not: fix these troubled loans so that more of our families here in Richmond can stay in their homes and our neighborhoods and local economy can recover."

Critics of Richmond's plan include the Securities Industry and Financial Markets Association (SIFMA).

SIFMA CEO Judd Gregg, former senator and governor of New Hampshire, warns that Richmond's actions will "hurt many more homeowners both within the city and around the country than it is alleged to help."

Greg warns that seizing mortgage loans through eminent domain will increase borrowing costs for home buyers and could restrict credit availability.

"The practical effect of this proposal will be that individual investors, who put their money into pension funds and other investment vehicles, making mortgage money available to homebuyers, will see their assets and savings arbitrarily, and we believe unconstitutionally, taken. This will not help expand mortgage credit availability in this country," Gregg said. "Programs exist, though they are often underutilized, that can better help homeowners in a more positive way than using eminent domain."

Here are five questions and answers about Richmond's plans:

1. What is the city of Richmond proposing to buy?

This week, Mayor McLaughlin sent letters to trustees of 626 underwater mortgage loans. The city had the loans appraised by Mortgage Industry Advisory Corporation on June 30 to determine their fair market value and offered to purchase the loans. She asked the owners and servicers of these loans to respond by Aug. 13.

An example in the New York Times provides a hypothetical example in which a home mortgaged for $400,000 is now worth $200,000:

The city plans to buy the loan for $160,000, or about 80 percent of the value of the home, a discount that factors in the risk of default.

Then, the city would write down the debt to $190,000 and allow the homeowner to refinance at the new amount, probably through a government program. The $30,000 difference goes to the city, the investors who put up the money to buy the loan, closing costs and M.R.P. The homeowner would go from owing twice what the home is worth to having $10,000 in equity.

Williams said the city is buying a loan, not any part of a security.

"The city is buying the loan from the trust, not anything from any holder of securities," he told ABC News. "The trust holds a diversified portfolio of loans, and the sale of one loan, such as a loan in Richmond, does not in any way degrade the value of any other loan that the trust holds, such as a loan to a borrower in Chicago."

2. Has this been done before?

While Richmond is the first city to move forward with this plan, it's not the first municipality to consider it. About 400 miles south of Richmond, San Bernardino County and two of its cities had previously considered using eminent domain to seize foreclosed properties on behalf of homeowners, but ultimately rejected the idea in January.

In 2004, the U.S. Supreme Court upheld the condemnation of private property in Connecticut for purposes of economic development in the case of Kelo v. City of New London.

A handful of other cities, like Newark, Seattle and North Las Vegas, are considering plans similar to that of Richmond, the New York Times reports.

3. How will the valuation of the homes work?

Richmond's plan is "likely to be permissible" after the Kelo case, says Illya Somin of George Mason University Law School, but under-compensation will be a "possible constitutional problem."

In eminent domain situations, the fifth amendment requires "just compensation," which the Supreme Court has interpreted as "fair market value."

The first problem, says Gideon Kanner, an expert in eminent domain and professor emeritus with Loyola Law School in Los Angeles, is "just compensation" has to be "first" paid in full, and up front.

If a condemner tries to low-ball too much and makes an unreasonable pre-trial offer, "it may have to pay the condemnees' attorneys' and appraiser's fees, plus other litigation expenses, on top of the 'just compensation," Kanner says.

Second, by state statute, the condemner has to pay "fair market value", Kanner explains in his blog, defined by statute as "the highest price" that a willing but unpressured buyer would voluntarily pay and be accepted by a willing but unpressured seller.

Dan Schechter, law professor at Loyola Law school, questions whether a financially troubled city can afford to make such payouts.

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(Credit: Justin Sullivan/Getty Images)

4. What kinds of recourse do the banks have?

One concern Kanner raises about Richmond's plan is whether bondholders would have to be paid "severance damages" if the remainder of a mortgage security loses its value after, say, some of it is taken by eminent domain.

In a case involving the NFL's Oakland Raiders, the California Supreme Court held that all species of property, including professional football franchises are subject to the power of eminent domain. Kanner says "in just about every eminent domain case" where the title to a property is taken, the lenders' interests are also taken, and they are entitled to just compensation, "which includes severance damages when the taking is partial."

Williams said, "the cities are happy to enter into negotiations with the trusts in order to reach an agreeable price, even if that means considering factors that the law does not require, such as the trusts' view of severance."

Williams adds that "even if the cities have to pay for the loss of diversification, the incremental payment would be negligible given the diversification and distressed nature of the loans in each pool." But Kanner said a jury will have to decide what that payment would be.

"However, if the trusts refuse to negotiate and the city decides to condemn then severance will not apply and the trusts will receive exactly the fair value of the loans - thus giving up, by their refusal to negotiate, the opportunity to receive more than fair value in a settlement," Williams said.

Kanner says a trustee holding a deed of trust has no authority to haggle over the value of the trust.

5. Why are people in the financial sector upset about this?

Schechter said Richmond's plan sets a "terrible precedent" for bond obligations.

"The idea in general is that bonds are not risky investments. The big asterisk here is generally true but folks at the C-level knew what they were doing," Schechter said. "High interest rates are the riskiest slice of residential mortgage backed securities."

"It's hard to feel sorry for them. They took a risk and it didn't pan out," Schechter said. "It explains why the industry is so up in arms about this."