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From Securities Regulation Daily, August 8, 2013

Banks file suit to stop city of Richmond’s plan to take underwater mortgages through eminent domain

By Matthew Garza, J.D.

Wells Fargo and Deutsche Bank have filed a lawsuit against the City of Richmond, California, seeking to stop the city from using the power of eminent domain to take underwater mortgage loans and refinance them at current market values. The city says the plan would help avoid further foreclosures, which have blighted the city and depressed its economy, but the banks allege that the losses that investors would suffer would violate the constitutional requirement of just compensation for a taking, as well as the Commerce Clause and Contract Clause. The “capricious use” of eminent domain by Richmond would also be taken into account by lenders, according to the banks’ complaint, reducing the availability of residential mortgage loans to its citizens. The suit seeks declaratory and injunctive relief (Wells Fargo Bank, National Association v. City of Richmond, California, August 7, 2013).

Offer letters. At the end of July the Richmond City Manager’s Office sent letters to banks and mortgage servicers offering to acquire the rights to certain underwater loans at their fair market value. Should an agreement on the purchase of the loans fail to be reached, the letter said, the city may decide to proceed with the acquisition of the loans through eminent domain, and “the owner will have the right to have the amount of just compensation to be paid by the city for the loans fixed by a court of law.” The letter requested a response no later than August 13, 2013.

Profit-driven scheme. The banks are leading a group of investors that claim the city’s plan violates the U.S. Constitution, the California Constitution, and other California laws. The plan, which the plaintiffs described as an “elaborate profit-driven scheme,” poses a threat to a vast number of pension plans, college savings plans, 401(k) plans, insurance companies, mutual funds, university endowments, and government-sponsored enterprises, and “potentially the entire U.S. mortgage industry.”

The lawsuit, filed in San Francisco, claims California investment firm Mortgage Resolution Partners LLC (MRP) has entered into an agreement with Richmond to take advantage of the municipality’s eminent domain power in order to seize loans at “steeply discounted prices” and refinance them with new federally insured loans in amounts above the amounts paid by Richmond to seize the original loan. The complaint alleges that MRP has made statements that it expects this strategy to generate profits of up to 20 percent for its investors. Richmond would also receive a portion of the profit, the complaint alleged, and “select Richmond homeowners” would receive a windfall by having their debt discharged.

The complaint also alleged that the taking of mortgages would “result in a massive transfer of wealth” from the beneficial owners of the mortgages, most of whom live outside of California, to “a few preferred private parties” in violation of constitutional prohibitions against the extraterritorial reach of the city’s authority.

The city’s assertion that the eminent domain plan would help prevent home abandonment, blight, and economic depression in the city was called a “mere façade” by the banks because the plan principally targets “performing” loans, or those that homeowners have continued to make payments on despite being underwater. The suit also claims that the plan, if implemented, would have a significant impact on interstate commerce and would violate the Commerce Clause and Contract Clause of the Constitution.

Industry response. The Securities Industry and Financial Markets Association (SIFMA) said the use of eminent domain to take mortgages could threaten the nascent housing recovery and would introduce new risks to the mortgage lending industry that would likely raise borrowing costs for home buyers. “SIFMA strongly opposes the use of eminent domain to seize mortgage loans, and believes it will harm the savings of everyday Americans around the country and have a negative impact on already stressed pension funds and the value of their investments,” the group said in a statement.

The Federal Housing Finance Agency, which regulates Fannie Mae, Freddie Mac, and the 12 Federal Home Loan Banks, also responded aggressively, saying “In response to an eminent domain action to restructure mortgage loans, FHFA may take any of the following steps: initiate legal challenges to any local or state action that sanctions the use of eminent domain to restructure mortgage loan contracts that affect FHFA’s regulated entities; act by order or by regulation to direct the regulated entities to limit, restrict or cease business activities within the jurisdiction of any state or local authority employing eminent domain to restructure mortgage loan contracts; or take such other actions as may be appropriate to respond to market uncertainty or increased costs created by any movement to put in place such programs.”

The case is No. CV 13 3663.

Attorneys: Rocky C. Tsai, John C. Ertman , Lee S. Gayer, Evan P. Lestell, Douglas H. Hallward-Driemeir, Daniel V. McCaughey (Ropes & Gray, LLP), for all plaintiffs; Thomas O. Jacob for Wells Fargo & Company

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