Mortgage Takings: The Next Appraisal Frontier or Liability?
According to the Appraisal Institute’s recently published 2013 Real Estate Appraisal Outlook, U.S. appraisers anticipate that litigation valuation/forensic appraisals will be one of the top five areas of growth in the next one to two years in both commercial and residential appraisal. Indeed, approximately 33% of surveyed commercial appraisers anticipate more demand from law firms and lawyers in the near future, with 24% of those surveyed expecting an increase in valuation consultation and studies in support of litigation. The appraisers’ prediction may be spot on the money as at least one U.S. municipality has begun to implement a plan to seize hundreds of underwater mortgages through its power of eminent domain, potentially paving the way for a steady demand of litigation-related appraisals.
At the end of July 2013, Richmond, California became the first city in the country to proceed with a plan to write down the value of underwater mortgages, transferring most of the value to the current homeowners. The city sent offer-to-purchase letters to 32 banks and other mortgage holders offering to buy approximately 620 underwater mortgages at discounts to the homes’ current value. In particular, Richmond is offering to pay lenders about 80% of a home’s currently assessed fair market value, regardless of whatever amount is still owed on the respective mortgage, which in the case of these “underwater” mortgages most often far exceeds the city’s offer. If the offers are rejected, the city proposes to use its eminent domain authority to condemn and seize the affected mortgages, paying court-determined fair market value for the same. After the properties are seized, the city would then refinance the homeowners into more affordable home loans.
The controversial mortgage plan…
The controversial mortgage plan was created and recommended by Mortgage Resolution Partners based in San Francisco, California. They first proposed their idea to Fontana and Ontario in San Bernardino County, California. However, Richmond was the first city to actually proceed forward with the plan and send out offer letters to mortgage holders.
On August 7, 2013, several mortgage-bond trustees filed suit in the United States District Court for the Northern District of California in San Francisco requesting a preliminary injunction against both Richmond and Mortgage Resolution Partners noting that the mortgage program could cost investors potential losses of over $200 million. See Wells Fargo Bank v. City of Richmond, No. 13-3663 (N.D. Cal. Aug. 7, 2013); Bank of New York Mellon v. City of Richmond, No. 13-3664 (N.D. Cal. Aug. 7, 2013).
The lawsuits charge Richmond with alleged violations of the Takings Clause of the U.S. and California Constitutions, applicable eminent domain law, as well as violations of due process and the Commerce and Contract Clauses of the U.S. Constitution. Plaintiffs in the suit contend that the national mortgage and housing industries will suffer great harm if Richmond was allowed to proceed. On August 8, 2013, the Federal Housing Finance Agency (“FHFA”) also voiced its objection to Richmond’s plan stating that it may direct Freddie Mac and Fannie Mae to cease all secondary mortgage business in communities that seize mortgages through eminent domain.
Notwithstanding this fervent opposition, there is legal precedent that potentially supports Richmond’s proposed mortgage plan. In 2005, the U.S. Supreme Court in Kelo v. City of New London, 545 U.S. 469 (2005), upheld the condemnation of private property for transfer to another private owner in Connecticut for purposes of economic development. Moreover, the California Supreme Court has previously held that “eminent domain law authorizes the taking of intangible property”, which could potentially include assets such as mortgages. City of Oakland v. Oakland Raiders (1982) 31 Cal. 3d 656.
Several other cities across the country, including Newark and Irvington, NJ, Seattle, WA, El Monte, CA, and North Las Vegas, NV, are contemplating the same or similar mortgage plans as the one being implemented in Richmond. Their respective decision to proceed forward with any such design will likely depend on how or whether Richmond succeeds with its proposal.
If Richmond’s public seizure of mortgages is allowed to proceed, the trend could catch on with cities across the country which would create a whole new market of opportunity for real estate appraisers to participate in these sweeping eminent domain actions. The question then arises of how appraisers will be affected in the long-term.
The 2008 real estate crash has already spurred widespread lawsuits by the Federal Deposit Insurance Corporation (“FDIC”) in its capacity as receiver of several failed U.S. banks. The FDIC’s deluge of litigation strives to shift liability away from banks towards appraisers on the theory that inflated appraisals were the true culprits for banks making poor loans before the real estate market collapse.
In the eminent domain context, a potential issue now arises of whether appraisers could again be held responsible for allegedly inappropriate appraisals causing banks additional losses. In this case, appraisers would be determining fair market value for underwater properties and their appraisals would directly determine what losses the banks would have to take on each underwater mortgage. As such, appraisers could again become an easy target for the banking and finance industries to recoup their losses from what was supposed to be an innovative public solution to struggling homeowners.
Ultimately, enterprising appraisers may want to be on the lookout for entrepreneurial developments and new opportunities borne out from Richmond’s, and perhaps other cities’, eminent domain efforts in the mortgage arena. However, they should also be wary of potential liability traps as history has demonstrated that the banking industry has no qualms with pointing fingers at appraisers nationwide.
Jonathan H. Yee, Esq. and Sanjay Bansal, Esq. are attorneys with Kaufman Dolowich & Voluck, LLP whose practices focuses on business and commercial litigation, professional liability defense, financial services disputes, employment matters, and real estate actions
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Great blog post. Im wondering if the city of Richmond is successful in taking these underwater properties through eminent domain of other city will follow through with a similar.
I think that just the threat of something like this happening nation wide will make the banks a lot more willing to modify current mortgages and write down the principal balances. This idea could, while causing millions in loss to investors, re-set the clock sort of speak back to 2003 or so and the economy might start moving again as we move away from this foreclosure crisis that does not appear to have an end in site.
Sounds like a check, to the balances. And we all know that mortgage origination wants absolute control of those checks. If the lending system was working correctly as is, ideas like the one stated in this article would never have come forth. / We could engage in more practical solutions like forcing rotational distribution of appraisal orders, so that preferential assignment does not allow only the most liberal of valuators to have top spot to receive all this work. You won’t catch the originators or the appraisers who service them supporting that idea though. Appraisers provide opinions of value, that lenders make lending decisions upon. Until such time as the appraiser interferes with a commission, then that appraiser is put out of rotation, permanently, often with secretive blacklists.
The lenders are claiming the seizures will cause them some $200 million in losses? Sorry, they’ve already lost the $200 million. The seizures will merely force them to recognize the losses.
Great point Lost Cause, great point.
I disagree with the author. the “fair value” of a seized mortgage may or may not have ANY direct relationship to the underlying property’s market value or its assessed valuation. A seized mortgage is personal property representing a security interest in real property. They are not sold in the same markets, nor are appraised the same way.
While I like a challenge as much as the next guy, I’d advise extreme caution and careful attention to SOW and intended use aspects of doing real property appraisals associated with these.