California Counties Take A Closer Look at Eminent Domain Homeowner Bailouts While Legal Experts and Industry Leaders Debate Its Legality

San Bernardino County is moving forward with its plan to explore the option of using eminent domain to seize underwater homes in an effort to staunch its foreclosure crisis.  I previously blogged about San Bernardino taking a first step in this direction by forming a Joint Powers Authority with two cities within its county lines, Ontario and Fontana.  According to recent reports, this Joint Powers Authority has recently directed its staff to draft a request for proposals from potential partners to help facilitate the scheme to forcibly refinance some underwater mortgages.  The most prominent of the potential partners likely to submit a proposal is Mortgage Resolution Partners, a San Francisco-based investment group that originally crafted the plan.  While San Bernardino continues to explore this option, Mortgage Resolution Partners is also shopping its proposal around different cities across the nation, including cities closer to home such as Sacramento, Elk Grove, and Rancho Cordova.  If implemented, the plan would target underwater mortgages, but only those that are current, purchasing the notes at a reduced value by use of eminent domain, and then using private capital to refinance the reduced debt. 

Needless to say, the plan is being met with debate and criticism by real estate industry leaders, legal experts, appraisers and bankers.  The Securities Industry and Financial Markets Association has issued a report challenging the plan, calling it an “opportunistic” way for investors to “cherry pick the best loans,” and warning that it could actually be detrimental to borrowers if lenders re-evaluate whether they want to lend funds in a community where there is a risk of having the local municipality abrogate their contracts with their borrowers.  This could also cause rates to go up and make loans harder to come by in those communities.  Legal experts are also debating the plan, particularly with regard to the formula for valuation of the loans to be taken.  In order for the plan to turn a profit, the government must be able to purchase the notes at a discount due to the possibility of default and foreclosure.  Critics note that eminent domain requires the government pay fair market value.  Legal opinions vary as to the appropriate amount of compensation, and, if implemented, the use of eminent domain in this manner will likely result in extended litigation over the valuation question.    

My own sense is that the plan will actually have very little helpful impact, as it cannot be used to purchase federal loans through Fannie Mae or Freddie Mac, which constitute close to 80% of the local at-risk mortgages.  There are also significant questions as to whether or not the use of eminent domain in this instance really serves a legitimate public purpose when the plan only targets loans that are current and ignores the homeowners who are in serious need because they are already in default and actually facing foreclosure.  Also, the plan is being promoted by a politically well-heeled investment group that stands to profit substantially at the expense of another group of investors who have done nothing wrong and will be losing some of the best assets in their already battered loan portfolios.