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The investor-government scheme

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POSTED July 15, 2012 11:04 p.m.

There are some ideas so convoluted that only an expert (or wannabe expert) could love them.

For example: collateralized debt obligations, which seemed like a good idea until the mortgage meltdown swamped the U.S. economy.

Into this hallowed territory comes a new instrument, playing its siren song.

San Francisco startup Mortgage Resolution Partners has come up with the brilliant idea of getting local governments to use the power of eminent domain to seize underwater mortgages and pay the mortgage holders something less than the market value of the home. That allows the homeowner to get a new, lower-balance mortgage that better reflects the home's worth and generates enough cash to allow the local government and Mortgage Resolution Partners to benefit.

The startup is trying to sell the scheme as a win-win for practically everyone harmed by the housing slump.

Underwater homeowners will enjoy lower mortgage payments. (Caveat emptor: Mortgage Resolution Partners doesn't want any mortgages in default.)

Cities no longer will have to worry about an exodus of foreclosed homeowners, who leave behind empty homes, which undercut the property values of entire neighborhoods.

Pension funds and other investors who hold the original mortgages are the only losers.

But maybe not, said Mortgage Resolution Partners Chairman Steven Gluckstern. Those who hold the mortgages already marked down the value because of falling prices; they are "no worse off and may be better off by provision of the liquidity."

Sounds too good to be true.

"The investors we represent don't think they're doing them a favor," said Ken Bentsen of the Securities Industry and Financial Markets Association. If this idea really is so great for current mortgage holders, let Mortgage Resolution Partners make arrangements on the open market.

In California, Fontana and Ontario and unincorporated parts of San Bernardino County, where about half the homes are underwater and local government is contemplating filing for bankruptcy, already have set up a joint powers authority. It could be the first-in-the-nation practitioner. To Bentsen, this means lenders will not be eager to issue new loans, as they, too, would be subject to seizure.

Mortgage Resolution Partners brass argues that the power of eminent domain is well-established, as long as local governments can point to a solid public use — in this case, preventing foreclosures.

Cornell University law professor Robert Hockett agrees. In the infamous 2005 Kelo decision, the U.S. Supreme Court ruled that local governments could seize private property for other private entities if there is a public purpose. In that case, New London, Conn., took the waterfront home of Susette Kelo as part of a redevelopment project anchored around Pfizer Inc.

Dana Berliner, an attorney for the Institute of Justice, which represented Kelo, said she believes that the California Supreme Court would overturn any law allowing governments to seize mortgages, because "it's a scheme by one group of securities investors to steal a bunch of money from another group of securities investors."

But what if Berliner is wrong?

"In California, there'll be very little that (governments) can't do," she said. "It would mean that eminent domain can be used to take from one group of people and give to another group of people to make a profit."

James Burling of the Pacific Legal Foundation sees too many opportunities for mischief because of political favoritism.

Think Kelo. Blue-collar homeowners lost their houses so that an "urban village" could replace them. Except the project never happened, and Pfizer closed its anchor operation.

Not to worry, say the folks at Mortgage Resolution Partners. The scheme is legal if the government pays fair market value. (If underwater homeowners think some deep-pocketed new authority didn't pay them enough, they can sue.)

Marrying cash-strapped local pols to brash capitalists usually doesn't make for more financial security. Come up with a truly tortured explanation for it, however, and you'd be surprised who will buy it.

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