San Francisco Mortgage Eminent Domain Plan - A Look at the Target Properties

On October 28, San Francisco Supervisors will consider forming a Homeownership Stabilization Authority with the city of Richmond. The Authority would have the ability to condemn residential mortgages as a way of keeping financially distressed owners in their homes. The focus would be on underwater properties with mortgages held in private loan securitizations; federally owned or guaranteed mortgages would be excluded.

I was surprised to learn that San Francisco has a problem with underwater mortgages. According to Zillow, the median home price in the City by the Bay peaked at $822,000 in 2007, bottomed out at $667,000 in late 2011, and has now reached $979,000 - 19% above the pre-recession high.

The Board of Supervisors' resolution states that San Francisco has approximately 300 underwater mortgages in private loan securitizations and that these are concentrated in "historically Black, Latino and Asian working class communities." 

Supporting documentation in the Supervisor's agenda packet includes a memo from ACCE Action stating that 279 San Francisco mortgages have LTV (loan-to-value) ratios of 107% or more. The memo breaks these mortgages down by zip code - with the highest concentrations in 94112 and 94124.

These two zip codes are in less affluent sections of the city where real estate prices have not performed as well as they have in the "hottest" neighborhoods.  That said, property in these zip codes is not seriously depressed by historical standards. In 94124 - which has seen the worst price performance - Zillow shows a median home value of $609,000 compared to a pre-recession peak of $635,000. Further, Zillow forecasts that within a year, the median will reach $636,000 - roughly equaling its previous peak. In 94112, Zillow only reports selling prices per square foot, and these have fully recovered from the recession.

Looking Beneath the Cover - Examining the Data

To learn more about San Francisco's underwater mortgages, I filed a public records request with the Mayor's Office of Housing and Community Development.  They provided the 279 mortgages in an Excel file along with other lists and correspondence.  There is a lot of material to work through, but I thought I would share some initial findings.

First, unlike in the case of Richmond, there are no property addresses, so it will not be possible to map the properties unless and until the list is matched against a public records database. CoreLogic and some other companies perform this sort of matching, but normally charge substantial fees for doing so.

Still, the file does contain information that should raise some eyebrows. For example, 47 of the 279 properties have current estimated values in excess of $1 million. Many of these are 2-4 unit properties, but there are 18 condominiums and single family houses in the million dollar-plus category. One home has an estimated value of $8.65 million after being originally appraised at $12 million.

Perhaps the biggest surprise is the number of loans that have been modified. According to the Board's resolution, homeowners whose loans were sold into private label securitizations "are unable to access many of the foreclosure prevention programs available to other struggling homeowners". Yet the data tell a different story:  129 of the 279 mortgages have had some kind of modification, such as principal reduction, interest rate reduction or additional time allowed for repayment. In many cases, multiple features of the mortgage were modified.

The resolution also notes that the vast majority of private label securitizations have "predatory" features. The features identified as predatory include negative amortization, interest only, balloon payments and adjustable rates. While I agree that negative amortization loans can be objectionable, I don't consider all these attributes to be necessarily predatory. Like many financial professionals, I have taken out ARMs on multiple occasions, and I never felt exploited. Indeed, since base interest rates are sharply lower than they were in 2007, it is likely that most ARM borrowers are paying little more than the original interest rates they incurred at origination. Of the 279 underwater San Francisco mortgages, 203 bear current interest rates of 4% or less - hardly predatory. Half of the universe consists of ARMs and another 49 are fixed rate.

Finally, it is worth noting that the vast majority of the underwater homes have multiple liens. In 244 of the 279 cases, the Combined LTV Ratio is different from the LTV Ratio, suggesting the presence of second and third mortgages. If one of the other liens is federally backed, the Authority may be challenged to liquidate the private mortgage while leaving the government mortgage intact. 

Undoubtedly, some San Francisco homeowners were sold predatory mortgage products by unscrupulous financial institutions. In some cases, these individuals may still be underwater because their homes were aggressively appraised or they live in neighborhoods with less robust price appreciation.

That said, we have yet to see a pool of mortgages that reliably falls into these categories. If the City cannot identify a set of mortgages that is fit for condemnation, the joint powers authority might benefit some undeserving homeowners - like the one with the $8.65 million house mentioned earlier. Further, if only a few dozen mortgages really do need to be liquidated, it is likely the City can find more cost effective means of doing so than through the use of eminent domain.

Richmond's Eminent Domain Program: It Could Really Happen

Richmond, California’s plan to use eminent domain to free city homeowners from underwater mortgages took a number of steps forward recently. Until this month, I would have given very long odds against Richmond actually going ahead with the plan, but now I would place the chances at close to 50/50.

The first development occurred last week in Washington with the Senate’s confirmation of Melvin Watt as Director of the Federal Home Finance Agency – which regulates Freddie Mac and Fannie Mae.  Under Acting Director Ed DeMarco, the agency had suggested it might prevent GSE financing in Richmond if the city moved forward with its plan to seize properties under the guise of eminent domain. The threat of not being able to get a Fannie or Freddie insured mortgage would have inflamed local opposition to the program. But, given Watt’s more progressive orientation, I doubt that he will continue DeMarco’s resistance. I suspect Watt is much more likely to look at the situation through the “little people vs. big banks” lens than his predecessor – whose career was devoted to the health of the home financing market.

The other developments occurred Tuesday night at the City Council meeting, the video of which is available here (most of the relevant discussion can be found between the 3 hour and 6 hour marks).  Mayor Gayle McLaughlin proposed and won passage of a motion that fine-tuned the program in a couple of important ways.

First, her measure imposed guidelines limiting the eminent domain program to mortgages below the conforming loan limit (now $729,750) and in struggling neighborhoods. This change addresses a revelation first made here at ExpectedLoss and later picked up in a WSJ blog and by the San Francisco Chronicle: that the program would have benefitted owners of some very expensive properties in affluent neighborhoods.

Second, the McLaughlin proposal calls for the eminent domain power to be exercised by a “Joint Powers Authority” rather than by the city itself. As reported by the Chronicle’s Carolyn Said, this change allows the eminent domain action to be approved by only a simple majority vote – rather than a super-majority as previously required. There appear to now be three solid “no” votes out of the seven officials who vote on the Council, so the need for a super majority appeared to be a deal breaker.  McLaughlin should be able to hold onto the four votes necessary to create the JPA and implement the eminent domain program. 

But the JPA device imposes a new challenge: another city would have to agree to participate in the JPA. Although McLaughlin and her supporters listed a number of potential partners in California and elsewhere, none of these cities have gone as far down the eminent domain path as has Richmond. Indeed, it is possible that none of these cities will ever get beyond the talking stage. This assessment applies especially to San Francisco – a city whose skyrocketing home prices have left few mortgages underwater.

A more likely candidate, El Monte, will need to be careful. The city declared a fiscal emergency in 2012 and some of its bonds carry non-investment grade ratings. Richmond has already been punished by the municipal bond market despite its superior fundamentals; it’s hard to see how a lesser credit like El Monte will attract investors if it goes ahead with eminent domain.

So the need to get a partner is a significant barrier – but not an insurmountable one. Undoubtedly, the ambitious folks at Mortgage Resolution Partners are very hard at work finding Richmond a mate. Of course, the path to finally condemning mortgages leads through the courthouse. Whether Richmond can prevail, with a very unusual interpretation of the takings clause, against a battalion of well-financed Wall Street lawyers is another bet entirely.