Aug. 2 (Bloomberg) — Richmond, California, sent the securities and real estate industries into a tizzy this week. The city said it is moving ahead with plans to use its power of eminent domain to seize home mortgages and restructure them for residents who owe more money than their homes are worth.
This would be a first in the U.S. Normally when governments do things that upset Wall Street millionaires it’s a sign they’re going down the right path. There are exceptions, of course.
Here is another story about Richmond, a city of about 106,500 on the east side of San Francisco Bay. In May, its No. 2 administrator, Leslie Knight, stepped down. A corruption investigation, which started with a whistleblower complaint, found she had been using municipal offices and employees to run a personal gift-basket and party-favor business. She was also collecting a car allowance and using a city car at the same time. She later paid back $10,000 to the city, according to local news reports.
Knight wasn’t fired. The city manager gave her a warning and let her resign as assistant city manager and head of human resources, which meant she got to keep her pension. Protesters have picketed the district attorney’s office demanding that he prosecute her. (He declined.) The Contra Costa Times in June wrote that Richmond’s city attorney “stonewalled, trying to block public access to documents about the case” — which were released only after the newspaper brought in its own lawyer. The same city officials would oversee the new eminent-domain program in one fashion or another.
This is the nature of local government in much of the U.S. It tends to be corrupt. Or at least it has been that way everywhere I have lived, from Colorado and New Jersey to Texas, Florida and Arkansas. It’s easy to see how a plan to grab loans from their out-of-town owners would inspire graft. Supposedly city governments would have to pay them fair compensation, but you can be assured most would offer less. The losers mainly would be bondholders that own mortgage-backed securities.
Richmond has 4,600 underwater mortgages. It sent purchase offers this week to the owners of several hundred. Just wait till some nosy gadfly or enterprising journalist figures out that some of those borrowers are friends, relatives or patrons of local politicians — or on the city’s payroll themselves. It’s bound to happen, if not in Richmond then in other municipalities that try to follow its example. Then picture the recriminations as folks figure out who scratched whose back in exchange for getting their principal balance reduced by tens or hundreds of thousands of dollars. This could be the biggest wealth creator to hit some small towns since the invention of roadside speed traps.
Imagine what would ensue if a program like this were tried in some ethically challenged city such as New Orleans or Miami. Or Hoboken, New Jersey, the town I call home, where two of the last four mayors have gone to prison for taking bribes. Where I live, it’s amazing what people have managed to accomplish with brown paper bags of cash and by knowing the right people.
Some residents who receive help could be hurt worse. Like game-show contestants who win a new car and suddenly find they owe the Internal Revenue Service more money than they have, the lucky borrowers might face big tax bills if their loan reductions wind up counting as income. I suppose the city can dream up something magical to make those debts vanish, too.
Perhaps using eminent domain in this way is legal. The big lobbying groups for the financial-services industry say it’s unconstitutional. So do civil libertarians. The government conservator for mortgage giants Fannie Mae and Freddie Mac last year said it “has significant concerns about the use of eminent domain to revise existing financial contracts.” Litigation would be inevitable and drag on for years.
Cornell law school professor Robert Hockett, in a Federal Reserve Bank of New York paper published in June, explained how a system like this would work. In typical academic fashion, he made it all seem so smooth and sensible. I can’t fathom how it would be in practice.
For instance, we learned from the banking scandals a few years ago that many of the companies trying to foreclose on people’s homes can’t prove who owns the mortgages. The problem cuts both ways. What will a city do when it can’t verify ownership of a loan, especially when it discovers this only after buying one?
Cities usually use eminent domain to seize land and buildings. If they’re going to start seizing home mortgages, why stop there? In some states cars are subject to local property taxes. Why not seize auto loans, in the name of economic development and promoting the public good? Maybe next they could go for people’s past-due credit card debt. How could anyone stand by idly and not help local voters who are deemed deserving, right? Then watch city officials complain when banks charge all of their constituents more money for credit because of their ZIP code.
Legal or not, well intentioned or otherwise, this is a horrible idea. The mortgage market may be dysfunctional, but the status quo is better than letting city employees choose winners and losers. It isn’t often that I can say this, but this time when the banks win, they will deserve to.
(Jonathan Weil is a Bloomberg View columnist.)
Photo: “BasicGov” via Flickr.com