Several California cities are exploring an expanded use of eminent domain to solve their housing crisis by seizing mortgages of distressed homeowners from banks and other lenders in a move that could backfire by deterring lenders from making future loans.
Eminent domain has been a long-established right of government to seize private property for public purposes, which once meant infrastructure development such as roads, water or sewer services or recreational needs.
Court rulings, particularly a 2005 Supreme Court decision, have expanded the power to allow municipalities to grab private property and transfer it to other private owners for a perceived public benefit such as new development leading to jobs and higher tax rolls. Owners of seized property have to be compensated at a fair market value.
But the plans before Californias San Bernadino County and two if its cities, Ontario and Fontana, would broaden the scope and reach of eminent domain to assist homeowners who are underwater, or owe more on their mortgages than their property is worth in a depressed housing market still struggling to recover from the recession.
Under a plan proposed by Mortgage Resolution Partners, the municipalities would use funds provided by private investors to seize underwater mortgages (not the homes) from banks at a reduced value of a mortgage. It would be the current fair market value that banks would be paid compelled to accept under eminent domain on the outstanding loan. The investor would then repackage or restructure the lowered mortgage to the advantage of the homeowner, who would no longer owe more than the property is worth and perhaps pay a lower interest rate.
The idea has yet to be tested in the courts, but municipalities see public benefits by avoiding blighted neighborhoods caused by foreclosures and abandoned properties.
Cities, counties and towns say they maintain their tax bases and encourage property owners to stay in their homes, even invest more in them.
Private investors win by getting their hands on cheaper mortgages that they can earn interest on over the life of 25- or 30-year mortgages. Homeowners win by saving thousands of dollars on reduced principal and interest costs.
The losers will be the banks and mortgage companies who will be out their investments on the initial mortgages. The plan amounts to a transfer of wealth from one lender to another favored by municipalities that act as a middle-man in the transfer of property acquired at lower cost..
I dont see how you could find it anything other than appalling, Scott Simon, a manager director Pacific Investment management Co., told the Wall Street Journal.
Even with record low mortgage rates, housing sales have lagged. Stricter lending requirements established since the market collapsed have made it more difficult for buyers to obtain a mortgage, and banks are being more cautious.
If banks now have to worry about governments moving in and taking over their mortgages their property at a loss, they will be even more reluctant to finance future home purchases needed to spur the housing recovery.