Richmond’s rules: Why one California town is keeping Wall Street up at night

Hacker News cognitive dissonance week:

  1) Creating technical arguments against court-ordered search warrants: heroic civil disobedience.
  2) Creating technical workarounds for mortgage debt paralysis: craven violation of sacred property rights.

It's not necessarily a fraud. The key is it only works in cases where the fair market value of the house is below the value of the mortgage. In that case, the city only has to pay the FMV. Now, there is always going to be some question about what is actually the FMV of a property. But this is true regardless of whether the city is in cahoots with a property developer who wants to put up some expensive shopping mall where single family homes once stood, or in this case where Richmond is proposing to seize by eminent domain houses which are underwater.

Why are the banks against this? (1) they believe they could get more at auction than the FMV determined by the eminent domain process, and (2) the seizure happens at a time outside of their control, where as the bank might be holding off on the foreclosure process since if they were to actually foreclose on the property, and discover from the auction that they could recover significantly less than the mortgage, they would then realize a loss which would screw up their capital holdings.

Either way, as far as the homeowners are concerned, they are effectively going to be foreclosed against. The only difference is that they will be offered a chance to continue to live in the house, and pay rent (which might or might not be at FMV; it's not clear from the description). Maybe it might be a rent with an option to buy, but basically the main goal of the city is to preserve the neighborhood instead of letting speculators buy the house at foreclosure.

So I wouldn't necessarily call it a scam. Will the banks lose out? Probably. But I don't know that they would necessarily lose out that badly --- that is, unless you don't believe that people who lose their houses due to eminent domain when a city is enriching some real estate developer isn't paying FMV to people who are turned out of their homes to build a shopping mall or a new stadium....

Can you elaborate as to exactly why a person who does not have the same opinion on both 1 and 2 must be suffering from "cognitive dissonance"? I don't see much of a relation between them.

It's an interesting hypothetical, but presumably there is data about how much mortgages are worth along all these axes, since they are traded fairly heavily. We don't need to guess about it.

The challenge here is that the mortgage has a different valuing scheme than the property. The mortgage is valued against the rate of return and the risk of default. The property is valued against comparable properties.

The whole problem here is that you might have a $200K mortgage which is written to a very credit worthy borrower who is paying on time, against a house with a market value of $100K (probably not in the Bay Area but this is just an example).

So the fair market value of a $200K mortgage, that matures in 2033 might be $100k (this is essentially a zero coupon bond at this point and we're assuming a 3.5% rate of return) could be "destroyed" (which is to say seized by eminent domain) and replaced with a $100K mortgage that matures in 2043 (assuming a 30 yr mortgage). That is worth something like $35,000 (again assuming an annual rate of 3.5%) which quite a bit less than $100K,

So looking at it as an investor you've had $100K worth of "principal" stolen from your retirement account by the City of Richmond, and sold to someone else for basically 1/3 the price, because the underlying basis for this particular investment vehicle was someones home, which is now underwater value wise.

The saddest part of the mortgage mess is that it is so freakishly complicated to figure out what or who owns a mortgage in the world of derivatives. If Richmond is successful (and I hope they are) the next story will be people who have this sudden drop in their 401k investment value with a note "Funds taken by City of Richmond" ) and those folks are going to go "WTF?" and the next round of scare stories will be "Richmond just yanked nearly a billion dollars out of people 401k funds and gave them to a Hedge fund, could you be next?" And nobody will be calling for the real reform which is some level of regulation on what you can and cannot do with a home mortgage security.