Transaction and Regulatory Distressed Property Task Force Legislative Committee
September 10, 2012
(This material is for discussion purposes only and has not been approved by the Transaction and Regulatory, Legislative Committees, the Distressed Property Task Force, Executive Committee or the Board of Directors)
Issue: Should C.A.R. sponsor legislation to limit the use of eminent domain power to take "upside-down" mortgage notes?
Options: 1. Sponsor legislation in 2013 to prohibit use of eminent domain to take notes. 2. Support legislative efforts by SIFMA (Securities Industry and Financial Markets Assn.) 3. Work at the federal level, in conjunction with NAR, to pre-empt the use of eminent domain 4. Wait until January 2013 to make a decision on legislation. 5. Other
The San Bernardino Experiment At the suggestion of a San Francisco based venture capital firm, Mortgage Resolution Partners (MRP) San Bernardino Count and two of its included cities have created a joint powers authority to explore local governments use of eminent domain authority to seize performing mortgage notes of "upside down" or "underwater" homeowners, and then refinance them at the homes' current value, and sell that new note to a new investor.
The proposal to use eminent domain has not yet actually been used, but has received broad attention throughout California and has been considered by cities in other states. San Bernardino seems closest to actually taking a note. The securities industry (SIFMA) and the Jarvis taxpayers association are reportedly threatening to sue if the local jurisdiction actually acts. Even worse, SIFMA and its allies are threatening the availability of all mortgage credit, even federally related/owned loans, in areas where the MRP proposal is implemented.
C.A.R. Existing Policy C.A.R. has existing policy to oppose the use of eminent domain to seize private asset to be given to a private party, as in the infamous Kelo vs. City of New London. C.A.R. supported ballot measures attempting enact constitutional changes to rein in the possible use of the process.
"Takings" of notes, vs. taking actual real estate, is a new proposal, but C.A.R.'s Distressed Property Task Force and Policy Committee leadership concluded that existing policy logically extends to opposition of the MRP proposal. While C.A.R. opposes the concept of using eminent domain to seize performing assets; some cities and counties may now be considering the use of eminent domain to seize non-performing assets as well.
In a conference call to review the possible application to non-performing notes, the Task Force recommended that the same policy should apply to all such takings and C.A.R. is opposed.
Details of the Proposal The proposed use of eminent domain comes from a private investment group that wants to be both a service provider and the broker/originator of a new note at a property's market value. The process is as follows:
- The local jurisdiction concludes that the risk of foreclosure on upside-down notes is such that they will soon go into default, imposing unacceptable burdens on the community and neighborhood.
- Based upon the need to avoid these consequences, there is a public necessity for the local government to act.
- The local government takes the mortgage note itself, not the actual property, and takes it by established condemnation process.
- Government can only take property with payment of fair compensation to the unwilling seller, in this case the lender or investor. Because the property has declined in value the fair value is set at either the new market value of the property or at an even more reduced "appraisal" of the fair value of the note being taken.
- The new owner of the note (the government) or its servicer (MRP) replaces the old note with a new note at market value and sells it into the secondary market. The proposed resale of the new note is thought to be why the scheme targets only performing notes. If the homeowner paying on the note is in default, his or her credit is suspect and the note may not be marketable.
- MRP receives a $5000 service fee, and commission or profit on the resale of the new note, and splits a share of the income with the local government entity.
1. Should C.A.R. be the lead on this issue, or should lenders or investors carry the issue forward with support, but not sponsorship, by C.A.R.?
2. Is the time ripe for a decision? C.A.R. has already expressed concern at the federal level to FHFA, the California legislature is in recess until January 2013 and can't introduce a bill until then anyway, no final decision has actually been made to go forward on the scheme, almost certain litigation has not yet been filed (let alone resolved), and local REALTORS® are actively involved in local opposition. Is it better wait until the January meeting to decide whether to "pull the trigger" on legislation?
3. What are the tax consequences of the debt restructuring scheme - would the debt forgiveness by the foreclosing local entity result in substantial tax liability to the homeowner? If so, that debt forgiveness needs to be included in the new federal law and conforming California law, or the scheme will have a strong disincentive for borrowers.
4. Is a legislative solution even possible? Given that the Supreme Court allowed a taking of private property for transfer to another private party in Kelo v New London, and given that California's constitutional amendment (Prop 99), a statutory prohibition will have to be carefully drafted.