Desperate times call for desperate measures. Six California cities and another in Nevada have latched onto a quick-fix scheme to take underwater mortgages by eminent domain.
The idea among officials in the California cities that include Richmond, El Monte and Pomona, and in the Nevada town of North Las Vegas, is to take the mortgage debt, leave home ownership intact and refinance the debt at the customary 80 percent loan-to-value ratio — reducing the amount outstanding, and with it, the likelihood of foreclosure.
Richmond, so far, has gone the furthest, telling mortgage companies earlier this month that the city was seeking to purchase mortgages on about 620 underwater properties and would use eminent-domain powers if the companies refused to turn them over. A group of banks quickly sued to stop the city’s move.
These cities are not the first, and likely not the last, of the nation’s hardest-hit communities to consider using eminent domain to address housing degradation from widespread foreclosure.
I represented the Securities Industry and Financial Markets Association when Brockton, Mass., entertained the notion. Admittedly, there is some appeal to the government stepping in to relieve working families from crippling mortgage debt and, by so doing, prevent urban blight. If it were only that simple. Or lawful.
The mortgages targeted for acquisition are those that have been pooled into private-label mortgage-backed securities (MBS) held by pension and mutual funds, among others. Fannie Mae and Freddie Mac also have private mortgage portfolios.
As a result, the taking of these mortgages in California and Nevada will have a ripple effect on investment value, and investors’ expectations, nationwide. Moreover, only performing mortgages are being targeted, meaning that only homeowners who are paying the monthly debt service will be selected for this form of government relief. Why?
Because once the takings are made, the city will flip the mortgages to a private investment fund that will pool them into MBS and sell them to other investors who are — quite sensibly — only interested in performing loans.
The scheme is just old wine in a new bottle, with a cynical twist. The nation’s urban renewal projects in the 1950s and ’60s took by eminent domain private property in declared blighted open areas and sold it to private redevelopers.
Although there is much to criticize about urban renewal, those were carefully planned and vetted public projects that were redevelopment projects, where viable housing, commercial and retail structures replaced residential slums. In 1954, the U.S. Supreme Court in Berman v. Parker sanctioned urban renewal eminent domain as being for a public purpose because it was part of a comprehensive plan to eliminate blight. Fifty-plus years of urban renewal ensued.
In 2005, the Supreme Court took that concept to an extreme in Kelo v. New London, where it sanctioned takings for economic development — no finding of blight required — so long as a plan was in place. Some misguided public officials, including, it appears, those in Richmond and elsewhere, have interpreted Kelo to mean that even the hint of some public good blesses the use of the taking power. That is not the law.
First, it is axiomatic that private property may only be taken for public use. The taking of private mortgages from one pool of MBS investors to sell them to another violates the Public Use Clause.
It is unlawful for the government to take property of one private owner to transfer it to another in what the Kelo court called a one-to-one transfer. Unlike urban renewal or the plan that saved the takings in Kelo, the proposed takings are not part of a comprehensive redevelopment plan. They are a bald transfer.
Second, the takings will invalidate the contract between the original borrower and lender. The Supreme Court has repeatedly held that laws retroactively abrogating or modifying debts are invalid under the Constitution’s Contracts Clause, which bars states from enacting any law that “impair[s] the Obligation of Contracts.” That is precisely what would happen under the scheme proposed.
Third, because all mortgage debt is pooled into MBS trusts, ownership of which is held in multiple states, the takings offend the Commerce Clause. Although the clause is most commonly thought of as a grant of power to the federal government, it also operates to prevent states and municipalities from burdening interstate commerce or discriminating against out-of-state interests.
Fourth, just compensation means fair market value — the price a willing buyer pays to a willing seller. At issue is the fair market value of performing loans.
It is difficult to understand how a performing loan is worth less than its face value, but the financial underpinning of the scheme is to pay only a fraction of face value as just compensation. Regardless, the value will be determined by juries, not municipalities.
And the risk of getting that value wrong may wreak more havoc on fragile municipal budgets, and therefore on the quality of life in these cities, than any predicted foreclosure activity. •