Richmond Responds to Foreclosure Crisis With Eminent Domain Plan

An industrial town of just over 100,000 people, Richmond, California, has suffered mightily in the recent recession. At one point, the city itself had to lay off a third of its employees. According to a declaration by Richmond’s City Manager filed in federal court, over 50% of the residents’ mortgages were “underwater” and 16% of mortgages have already gone into foreclosure.

Richmond’s government decided to take a gamble on a decidedly uncertain tactic to try to prevent foreclosures.

Richmond’s Plan

Many economists and urban planners believe that home foreclosures lead to blight because the defaulting owners are forced to abandon the properties, which are frequently left to decay due to poor maintenance by the financial institutions that take them over. The Richmond City Manager, mayor, and several city council members, along with a private firm, put together a proposal to try to prevent more foreclosures by using the city’s power of “eminent domain” to leverage taking control of underwater mortgages.

For those fortunate enough not to know, a mortgage is “underwater” when the amount owed on a home exceeds the fair market value of the house.

The plan is for Richmond to take control of underwater mortgages to prevent foreclosures so that residents can stay in their homes. The city would first offer to buy out the investors who currently hold the underwater mortgages and, if the investors refuse to sell, the city would take control of the mortgages by forcing the investors to sell the mortgages to the city at fair market value (through “eminent domain”). Richmond has partnered with a firm set up to marshal investors to create a fund for the city to buy out the mortgages.

But the plan is controversial—it passed the city council only after a seven-hour meeting that ran from the evening of September 10, 2013  until very early on September 11. And, the city had to abandon an effort to sell $34 million in bonds to fund the plan when it found no takers.

Part of the controversy revolves around the “stick” of eminent domain that is a large part of the plan.

Eminent domain

The colonists brought the concept of eminent domain with them from England, where it described the power of the throne to take unimproved land without compensation. Under the U.S. Constitution, eminent domain is the power of a governmental body to take property without the owner’s consent, but with compensation, for the public benefit. Some familiar examples of the government’s exercise of eminent domain include seizures of property to lay rail lines, build highways, or establish parks. While the government traditionally used eminent domain to take private property for public use, the power has expanded over time to encompass government takings for a broader “public benefit,” including a recent seizure of land to build a shopping mall.

Although the government has the power to seize private property for the public benefit, it has to pay for it under the Fifth Amendment to the Constitution, which prohibits confiscation of property without just compensation. But, “just compensation” does not mean that the property owner gets to bargain with the government; rather, the government unilaterally decides what compensation is just.

Mortgages are a type of property. Under its power of eminent domain, Richmond has argued that it has the authority to take over the mortgages in return for paying fair market value to the current mortgage holders. Now, this price will be below the current mortgage prices, which is why the properties are considered underwater, and why the city has to use legal measures to accomplish the taking. It’s not really a voluntary sale.

Political opposition

Richmond’s partner in all this, Mortgage Resolution Partners, created the essential financial structure for the plan and has shopped it to other cities, including Las Vegas and San Bernardino. So far, Richmond is the only taker. This may be due, in part, to the strident lobbying of the financial industry against such plans. The lobbyists are opposed to the plans because banks do not want to have to bear the risk of municipal seizure of assets backing loans they make.

Bankers have gone to Washington to urge the passage of a federal law that would ban such plans, and have delivered written warnings to cities considering similar plans detailing how difficult it would be for city residents to obtain loans if the plans were passed. The implication of these warnings is that financial institutions will be reluctant to extend loans in localities where the government may step in if homeowners default. The financial industry also threatened litigation, a threat it made good on in response to the Richmond plan. In the Richmond lawsuit, the financial institutions argued that Richmond had exceeded its constitutional authority by passing the foreclosure act and that any seizure of mortgages by eminent domain would not be for the public good and would not be justly compensated.

Legal opposition

In July 2013, Richmond sent letters to several hundred of the financial institutions holding underwater mortgages, asking them to sell the mortgages to the city for fair market value. The institutions, including Wells Fargo, refused and responded further by suing Richmond in federal court to try to derail the plan.

On the same day that Richmond’s city council voted to adopt the eminent domain plan, the federal judge hearing the banks’ lawsuit declined to issue an injunction to stop the plan. The court  dismissed the lawsuit a few days later because the city had not yet exercised its power of eminent domain. The banks and other financial groups affected could file new lawsuits once the city actually seizes a mortgage.

Richmond will almost certainly face further litigation after it exercises eminent domain and actually takes properties. A further complication for Richmond is the cost of such litigation: Mortgage Resolution Partners agreed to cover the city’s costs in defending the banks’ lawsuit, but has informed the city that it cannot secure insurance to cover a judgment against Richmond should it lose a legal challenge to its exercise of eminent domain.

A Novel Measure That Could Alter Foreclosures Nationwide

If Richmond can win the political and legal battles and successfully exercise eminent domain to take over underwater mortgages, other cities will surely take notice. The risky bet by Richmond could gain popularity as a Hail Mary gambit by other cities desperate to keep people in their homes.

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