California Authorities Consider Seizing Mortgages Secured by Residential Properties

by Dechert LLP

photo of Laurie NelsonIt’s no secret that California has been hit harder than most states by the housing crisis. Just east of Los Angeles, the county of San Bernardino has cities with some of the highest foreclosure rates in the U.S.

On July 18, the San Bernardino City Council declared a fiscal emergency and voted to file for Chapter 9 bankruptcy protection.

Attempting to stimulate the local economy, the county of San Bernardino entered into an agreement with two of its cities, Fontana and Ontario, to create the Homeownership Protection Program Joint Powers Authority (“JPA”) “to explore a variety of proposals to assist homeowners within their jurisdictions who are underwater on their mortgages.” Currently, the JPA is considering a controversial eminent domain plan put forth by Mortgage Resolution Partners (“MRP”), a San Francisco-based venture-capital firm, whereby (based upon publicly available information) underwater performing residential mortgage loans held in private-label securitizations would be seized, refinanced or restructured and sold to third-party investors, with the government recovering administrative costs and MRP earning a fee on each transaction (the “Program”). On July 13, the JPA held its first organizational meeting where it created the structure for moving forward and heard a handful of public comments from opponents of the Program. The next meeting of the JPA is planned for August 16. The Joint Exercise of Powers Agreement states that the Homeownership Protection Program established by the JPA “may include the Authority’s acquisition of underwater residential mortgage loans by voluntary purchase or eminent domain and the restructuring of these loans to allow homeowners to continue to own and occupy their homes.”

Eminent domain is basically the power of the government or quasi-government agencies such as highway commissions and utility companies to take private property for public use without the owner’s consent. Here, the state isn’t bull-dozing someone’s house because it’s in the path of the new highway being built. Instead, the homeowner (who is current on his mortgage payments) is allowed to stay in his home. The government would take his mortgage loan from its current holder and refinance or otherwise restructure the loan with a new holder such that the homeowner can now acquire equity and make lower mortgage payments each month. Novel idea -- with some undesirable consequences.

On June 28, eighteen national, state and local organizations submitted to San Bernardino County a letter opposing the Program. The letter has drawn much attention to the issue.

On July 19, the Securities Industry and Financial Markets Association (“SIFMA”), issued a statement discussing the impact of the Program on the To-Be-Announced (“TBA”) market and introducing a policy regarding the interaction of eminent domain with TBA trading whereby loans to borrowers residing in areas that municipalities have initiated condemnation proceedings to involuntarily seize mortgage loans through their powers of eminent domain will not be deliverable into TBA-eligible securities on a going-forward basis.

Gregory Devereaux is the Chief Executive Officer of San Bernardino County and chairperson of the JPA. Despite reports that officials in San Bernardino County began talking with MRP about the proposal to seize underwater mortgages back in January 2012 (months before MRP’s involvement became public), and that the county signed an agreement with MRP not to disclose those communications, Devereaux stated in the July 13 meeting that the JPA was formed to explore ideas and programs to address the housing crisis “openly and with the community as a whole,” and he stated “there are currently no proposals or programs before this body.”

A professor of finance at the University of Chicago business school argues that restructuring debt contracts is a valuable and important part of the financial system because there comes a point when it becomes impossible to impose further losses on debtors, and that creditors are then expected to take losses on their positions. He says that in corporations and commercial real estate, such restructuring happens every day and notes it isn’t happening in the mortgage markets.

Proponents say the Program would target mortgage loans that cannot be written down but would otherwise be written down because it is in the interests of the investors to do so. They argue that the use of eminent domain is a means of getting around restrictive securitization documents that prevent mortgage loan modifications.

I did not get the impression that Devereaux is married to the eminent domain plan of attack but that he is a bit taken back by the fast and furious opposition. To me, he appeared to be pleading that alternative solutions to the housing mess in San Bernardino County be presented to the JPA. Hopefully some alternative ideas will come his way (I hear that other proposals are currently being prepared for submission) because the Program would not likely survive any of a plethora of legal challenges, a few of which are briefly discussed below.

The U.S. Constitution requires that private property be taken only for “public use.” The government may not take private property under the pretext of a public purpose when the actual purpose is to bestow a private benefit. Opponents are speaking out and concurring that if the Program is adopted, San Bernardino county residents will be subject to increased costs for credit because performing loans would now be subject to possible seizure by the government at a discount. This affects mortgage pool valuations and mortgage-backed securities valuations. Resultant losses would likely reduce access to credit for borrowers in San Bernardino County as mortgage interest rates increase, which would lead to decreased demand for homes in San Bernardino County, which would lead to lower home values… Therefore, it would be difficult for the JPA to demonstrate that the Program is necessary to attain the economic benefits touted.

MRP is certainly contemplating earning a dime here, so the existing mortgage holders must be paid less than fair market value, a violation of the Fifth Amendment because private property cannot be taken “without just compensation” (which would presumably be “fair market value”). The Program is designed to prevent a fair market value ascertainment. Further, pooled loans in securitizations arguably have even higher values than if valued independently, values above the amount I understand will ultimately be paid for the seized loans, at a huge loss to mortgage-backed securities holders. The Program assumes a “forfeiture discount” when determining the fair market value of a loan -- an assumption that if a borrower is underwater, foreclosure is a certain result; but many performing underwater loans never default.

The Program may also violate the U.S. Constitution if it is found to interfere with interstate commerce such as disrupting the mortgage-backed securities market. And the Program may violate the U.S. Constitution if it is found to impair contract rights. The U.S. Supreme Court has repeatedly held that states have no authority to abrogate debts and transfer them to other private parties. If you are interested in citations to relevant case law, click here for the Dechert OnPoint.

There are a variety of California state laws that would likely be violated as well.

And if courts ultimately find that the fair market values for the mortgage notes are substantially different than MRP’s valuation, the JPA (and/or participating municipalities) may well be liable for paying the difference to the securitization trusts as just compensation.

Proponents and opponents of the Program do appear to agree on this: the Program, if adopted, will likely end up in court.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Dechert LLP | Attorney Advertising

Written by:

Dechert LLP

Dechert LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.