On a drizzly November morning, Steven Gluckstern speeds through the half-empty subdivisions that spread out for miles as you head east from San Francisco into California's Central Valley. Taking the exit in downtown Merced, a small city that's hit hard times, he passes a grizzled panhandler holding a sign that says, "Will work to get out of Hell." The 61-year-old venture capitalist taps the steering wheel of his Volkswagen SUV and hums along to "Like A Rolling Stone," getting himself psyched up to make his pitch.
He parks and bounds into Merced's modest city hall to speak to a small gathering of city council members, realtors, and housing activists. "If we sit around and wait for the solution to come from Washington, DC, or Sacramento, it will not come," Gluckstern tells them between deep dives into stats on underwater mortgages, negative home equity, and loan default rates. "It will not come! It hasn't come in five years."
Merced, whose foreclosure rate is twice the national average, is just the latest stop as Gluckstern crisscrosses California to sell struggling cities on a radical, untested way to fix the mortgage crisis. His scheme is almost as complicated as the derivatives and collateralized debt obligations that caused this mess to begin with. However, its underlying mechanism is simple: Cities should use the power of eminent domain to seize troubled mortgages from the bondholders that own them.
Steven Gluckstern in his San Francisco office
Josh Harkinson
That's where Gluckstern's firm, Mortgage Resolution Partners, enters. It would arrange the funding for these eminent-domain purchases and then help a city like Merced reduce the loans' principal and resell them to new investors, who'd cover the city's costs and MRP's brokerage fee. In this scenario, Gluckstern calculates that a family in Merced that bought a $200,000 house that's now worth $100,000 (a common situation here) would see its monthly payments decrease from between $800 to $300.*
"Everybody is better off," Gluckstern says as he clicks through slides detailing how preventing a single foreclosure could save the city nearly $20,000 in lost taxes and other expenses. "Grandma is better off because she stays in her house. The community is better off because you avoid all of those costs." It's also a good deal for the investors who own the mortgage, he continues: "But you know something? Even the owner of that mortgage is better off, because that's otherwise going to be a foreclosure. And we know there are 8 chances out of 10 that they are going to be foreclosed!"
Even as housing prices slowly rebound across the country, the situation in California's Central Valley is not unique. Four million Americans have lost their homes since 2005, and 3 million home loans are currently at or near foreclosure. Moreover, 12 million borrowers collectively owe $600 billion more than their homes are worth, a debt load that threatens to stall the shaky economic recovery.
Dozens of cities and counties have expressed interest in pursuing the eminent domain option with MRP, including Chicago, Berkeley, and New York's Suffolk County, though nobody wants to be the first to try it. Last April, officials in California's San Bernardino County appeared ready to work with MRP until the securities and banking industries bombarded them with threatening letters. Last month, the central California farming town of Salinas quietly solicited a bid from MRP, but has yet to pull the trigger.
Former San Francisco Mayors Gavin Newsom
and Willie Brown are among Gluckstern's
influential Democratic allies. Thomas Hawk/Flickr
Politicians are understandably reluctant to resort to what is essentially the nuclear option for rescuing beleaguered homeowners. In August, the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, posted a notice expressing its "significant concerns about the use of eminent domain to revise existing financial contracts." In September, the Securities Industry and Financial Markets Association warned that any city that seizes a loan will face a crippling legal battle as well as a "chilling effect" as banks hike interest rates or pull up stakes entirely.
The hesitancy may also have something to do with Gluckstern and his partners, who, after all, have a lot in common with the bankers they're supposed to be fighting. MRP's CEO, Graham Williams, is the former director of residential lending for Bank of America, and Gluckstern's investors include Donald Putnam, who once managed $15 billion in mutual funds. His allies include business-friendly Democrats such as former San Francisco mayors Willie Brown (an MRP investor) and California Lt. Gov. Gavin Newsom. MRP spokesman Peter Ragone previously served as Newsom's spokesman. MRP's team also includes a prominent real estate developer, the founder of Ask Jeeves, and a former legal affairs secretary for California Gov. Jerry Brown.
In response, Gluckstern's foes in the finance industry are fighting him with rhetoric that sounds like something from an Occupy protest. Writing to San Bernardino officials in July, the Association of Mortgage Investors described MRP's eminent domain scheme as "simply a wealth transfer from everyday Californians to a handful of wealthy, well-connected investment bankers."
Gluckstern's approach isn't as in-your-face as it may sound. In early 2008, the Obama administration considered a bottom-up fix to the foreclosure crisis that had a lot in common with MRP's proposal. The federal government had bailed out the banks but liberal economists were arguing that it also needed to bail out millions of homeowners struggling to stay afloat. Last year, the White House finally began warming up to that idea. But it has stood by as Edward DeMarco, FHFA's acting director, has ignored the entreaties to forgive debt on government-owned loans.
The eminent domain plan was the brainchild of Robert Hockett, a Cornell law professor who specializes in the securitized mortgage market. Hockett originally wanted the government to use its power of eminent domain along with money from the Troubled Asset Relief Program to go after underwater mortgages owned by private investors—namely, the so-called private-label securities that own 10 percent of all mortgages but account for a third of all foreclosures. Hockett describes them as "suicide pacts" because they were devised without any way for their owners to modify the underlying loans. "After it became apparent that the feds weren't going to do this," Hockett says, "I thought, 'Well, let's try it some other way.'"
"I know what threats are. I know what bullying looks like. And I didn't like it coming from the folks that I helped bail out," Newsom says.
That other way became apparent last year when John Vlahoplus, a friend from Hockett's days as a Rhodes scholar, told him about MRP's business plan. Vlahoplus, MRP's chief strategy officer, wanted to make sure that it could withstand a challenge in the Supreme Court. (The Fifth Amendment enshrines the government's right to seize private property for public use, provided it pays just compensation.) Hockett believed it could.
"The broad category of property that we are taking about here is intangible property, and there has never been any question that intangible property can be taken," Hockett explains. He cites examples of eminent domain being used to seize railroad stock and municipal revenue bonds. Of course, cities must demonstrate that taking private property accomplishes a public good, and the benefits of seizing underwater mortgages are somewhat speculative. But so was the public benefit of seizing homes in New London, Connecticut, to make way for a Pfizer research facility—a use of eminent domain that the Supreme Court approved in its controversial 2005 Kelo v. New London ruling.
Lawyers for SIFMA, the securities industry trade group, point out that MRP seeks to cherry-pick performing loans from mortgage-backed securities. That means cities would seize loans whose borrowers are still current on their payments without compensating the bondholders for essentially wrecking the value of their remaining securities, which would be loaded with nonperforming loans that are unlikely to ever be paid off. "The difference between the compensation contemplated by MRP," they write, "and the compensation actually required by the Constitution and state law, is likely to be substantial."
Gluckstern calls this posturing. Studies suggest that 80 percent of underwater mortgages owned by private-label securities will end up defaulting. "We're taking the cherry bombs, not the cherries," he says, "because these are the ones that are going to explode." He argues that MRP isn't seeking windfall profits; it will charge a flat fee of $4,500 per loan it helps acquire, the same fee that the federal government pays loan servicers to modify existing mortgages. The real profiteers, he says, are the speculators who bought mortgage-backed securities on the cheap with the expectation of huge payouts. "The idea that a local community is going to challenge Wall Street's dominance of the financial system? That's why they are in an uproar."
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