Use of Eminent Domain to Restructure Underwater Mortgages Is a Bad Idea

The mayor of Richmond, Calif., announced this week that the city has written 32 mortgage servicers offering to buy 624 underwater mortgages held by private-label mortgage-backed securities in order to refinance the loan to a lower payment.

If a servicer does not accept the offer, the letters say, “the City [may] decide to proceed with the acquisition of the Loans through eminent domain,” with the loan holder receiving court-determined compensation. The San Francisco Bay area city, hit hard by the bursting of the housing bubble, is offering 80 percent of what it says is “fair market value” for the loans as of June 30. (below is a sample letter sent by the mayor of Richmond)

Other cities have also threatened to use eminent domain to acquire underwater loans; but have not followed through on this threat.

However, the use of eminent domain to abrogate a contractual agreement between borrower and creditor will adversely impact the U.S. mortgage markets and in specific communities using eminent domain, the impact will be a significant contraction of credit availability.

In addition, ABA, credit union trade groups, and other housing finance trade groups wrote to House members on Monday to support an amendment that would prohibit the Federal Housing Administration from insuring residential mortgages seized through eminent domain.

In the letter, this coalition of trade groups wrote: "The amendment has become necessary because numerous communities across the country are considering a plan developed by a vulture fund that envisions using a municipality’s eminent domain power to acquire performing but underwater mortgage loans held in private-label mortgage-backed securities and then insure the new loans through the taxpayer-backed FHA."

Read the letter.