Will the City of Richmond’s Plan to Condemn Mortgages Really Cost Taxpayers Nothing?

In an earlier post, I noted that one of the problems with the California City of Richmond’s plan to use eminent domain to condemn mortgages is that taxpayers will have to pay for it. However, some defenders of the plan – such as Mortgage Resolution Partners – the “community advisory” firm that has been hired to organize the plan for the city – claim that “no taxpayer funds will be used in connection with the [p]rogram.”

This claim is hard to credit, given that any time the government condemns property, it must pay fair market value compensation. Therefore, the city of Richmond will have to spend public funds to condemn the mortgages, at least initially. MRP’s position seems to be based on the idea that, after writing down the condemned mortgages, the City will transfer them to investors who put up money to buy the now-reduced loan, thereby offsetting the public funds spent on the taking. As the New York Times explains, the city could take a $400,000 mortgage on a home now valued at $200,000, condemn it while paying only $160,000 in compensation, and then restructure it into a new $190,000 loan that could be sold to private investors. Advocates assume that the city, MRP itself (which is to be paid $4500 per mortgage), and the investors could actually profit from the $30,000 difference.

Unfortunately, there are two serious flaws in this reasoning. First, it assumes that investors really will be eager to purchase the new mortgages at a price that will offset the city’s costs. This is far from certain. The very fact that the city has condemned these mortgages in the first place is likely to lead future investors to be wary of mortgages in this area. After all, the city could resort to eminent domain again in the future, if home values fall again. Moreover, the Federal Housing Finance Administration has announced that it will forbid Fannie Mae and Freddie Mac from doing business with local governments that use eminent domain to condemn mortgages. Indeed, Fannie and Freddie are among the plaintiffs currently suing the City over its plan (they own some of the assets threatened with condemnation). These two government-backed firms back the majority of the nation’s mortgages. Investors are likely to view mortgages ineligible for such backing less favorably than similarly priced mortgages that are eligible. I am no fan of Fannie and Freddie, and the federal governments’ support for them. But the relevant point here is that removing them from the picture makes it less likely that the city of Richmond can recoup the money it spends on compensation.

The more important problem is that the city’s and MRP’s calculations are based on the payment of compensation far below market value. This has already led to litigation. Ultimately, the city is likely to lose many of these cases, and be forced to pay much higher compensation, or give up the takings entirely. Either way, taxpayers will be on the hook – either for the increased compensation payments or for litigation costs, or both. The litigation costs themselves are also likely to be substantial. The major banks and other investors who currently own the threatened mortgages are not going to give up easily, and there is likely to be a prolonged legal battle.

Ultimately, therefore, it is highly unlikely that Richmond taxpayers will get a free lunch here. If the plan survives at all, it is likely only because they will end up paying far more in compensation than originally envisioned.