Robert and Patricia Castillo, a California couple who have already had their monthly mortgage payments cut by almost 60%, want the city of Richmond to reduce their debt by using its powers of
The Castillos owe $436,500 on two loans on a three-bedroom home that’s now worth about $125,000. The hospitals are members of a mutual insurer that’s among investors in the Pimco High Yield Fund, which owns a slice of bonds backed by loans including the Castillos’.
At least a dozen cities, still dealing with the fallout of the housing bust, are studying proposals to confiscate home loans and write them down to help homeowners escape oversized debt burdens. Pacific Investment Management Co., which is known as Pimco and manages the world’s largest bond fund, is among mortgage-securities investors organizing a coalition to take legal action to oppose the push, according to three people with knowledge of the discussions.
The program is advocated by Steven Gluckstern’s Mortgage Resolution Partners LLC, which would provide services and arrange for private investment funds that would profit by buying the loans for less than property values, and reworking them.
Eminent domain, the right of governments to take private property for the public good while providing fair compensation to the owner, has typically been used to seize real estate, such as to build highways or parks.
Eminent domain has also been applied to intangible assets such as mortgages, said Robert Hockett, a law professor at Cornell University, who has been among the biggest proponents. Hockett said, “It’s a perfectly garden variety use of eminent domain authority.”
The financial industry disputes that claim.
It’s a “misguided approach” to solving a community’s housing problems, said BlackRock Inc. vice chairman Barbara Novick, whose firm is the world’s largest money manager.
“This is a flagrant misuse of an important public policy tool and will have negative impacts on availability of credit and cost of credit for the entire community while helping relatively few homeowners,” she said Wednesday in an email.
Richmond is furthest along in implementing the idea. A private investment fund would buy the loans at prices based on financial models or comparable trades. The mortgages would be reduced and refinanced into new debt insured by the Federal Housing Administration.
The battle is a legacy of the housing bubble that began to burst seven years ago. Cities considering using eminent domain are worse off than the country as a whole, and proponents say it will reduce blight and costs to communities by heading off foreclosures caused by negative equity.
Delinquencies have declined across the U.S. as more borrowers regained equity in their homes and the economy improves, according to data provider CoreLogic Inc. Completed foreclosures fell 20% to 55,000 in June from a year earlier. In Richmond, there were 47 preforeclosure filings this year through May, down 64% from the same period last year, CoreLogic data show.
Patricia Castillo, 41, said she feels trapped in the house that she and her husband bought in Richmond for $420,000 near the height of the housing boom in 2005, because they have no equity and no money to repair the deteriorating property.
“I feel like we’re just renting,” she said in a telephone interview from the home, where she cares for her 24-year-old son, Leon, who is disabled. “I’m not building any equity to fix the house.”
Their mortgage was bundled into a bond transaction known as Lehman XS Trust 2006-GP4, according to a note to clients this week by RBS Securities Inc. strategist Scott Gimpel. The information he assembled on the loan was from CoreLogic and public records.
Castillo said they need to own their home because their son needs a safe place where they aren’t subject to a landlord. She said their lender deceived them when they originally got their mortgage, which is why they support Richmond’s eminent domain effort.
“We didn’t know any better,” she said. “I feel they should pay the consequences for giving us that loan.”
The $17.3 billion Pimco High Yield Fund is invested in one tranche of the Lehman XS Trust securities, and an investor in that fund is the Missouri Hospital Plan, according to data compiled by Bloomberg.
If the loan is acquired for too low of a price, it could lower the bond’s yield, and returns in the Pimco fund.
Lower investment income could raise insurance costs for the plan’s members, though “you’d have to look at it in the context of the overall portfolio,” said Joe Moody, chief executive officer of the HSG Family of Companies, which manages it.
“There are some of these loans if you write them down it renders the homeowner and the bondholder better off,” he said. “If that premise is correct, there’s no reason you can’t have an amicable agreement.”
The industry is wary of that view and Hockett said that he has been unable to persuade federal regulators to back a mediation process.
The 32 servicers and bond trustees that oversee the loans aren’t likely to sell willingly, according to Chris Killian, head of the securitization group for the Securities Industry and Financial Markets Association, Wall Street’s largest lobbying organization. That’s because of the nature of the bond contracts and their view that it’s generally a “bad idea.”
Richmond Mayor Gayle McLaughlin said on a call with reporters that she would take the industry to court for illegal redlining, or restricting loans in certain areas such as minority or low-income neighborhoods, if they make it harder to borrow in her city.
Any use of eminent domain would necessarily involve court oversight to determine if fair prices are being paid, which is why investors shouldn’t be concerned that the values will be too low, according to Mortgage Resolution Partners.
“Of course we’ll see you in court,” chief strategy officer John Vlahoplus said in a telephone interview. “We’ll sue you first.”
