A plan to use eminent domain to seize underwater mortgages has raised hopes of homeowner bailouts in cities stricken by the housing crisis.
But would such a novel plan even be legal?
Experts say the proposal being shopped around by San Francisco’s Mortgage Resolution Partners may well meet the U.S. Supreme Court’s broad definition of a public use under eminent domain law. The investor group is encouraging cities and counties to condemn mortgages and cut the amount borrowers owe to prevent blight and boost local economies.
The sticking point, legal experts say, will be when it comes to paying the "just compensation" required under the U.S. Constitution.
"My guess is the courts will uphold the constitutionality of this, but it will be messy," said Steven J. Eagle, an expert in government takings at the George Mason University School of Law in Arlington, Va.
Mortgage Resolution Partners was formed at the start of the year to promote a plan it said would both bolster the housing market and turn a profit for its investors.
Chairman Steven Gluckstern, a venture capitalist and one-time owner of the New York Islanders hockey team, has been talking to cities and counties around the country, advocating his plan. San Bernardino County, Calif., already has formed a joint powers authority with the cities of Fontana and Ontario to consider the proposal. Chicago leaders held a hearing on it this week.
Mortgage Resolution Partners is proposing that local governments seize the mortgages of homeowners who are underwater but current on their payments, and whose loans are held by private investment trusts. To turn a profit, the plan relies on governments paying less than the current market value of the homes that secure them.
Gluckstern contends that the notes are worth less than the value of the houses because owners are more likely to default if they owe more than their homes are worth. The purchase price should be discounted by the potential costs of foreclosure, he said in a recent interview.
For investors who own mortgage-backed securities, that would mean losing the best loans from the bundle of mortgages that generate their investment income.
MRP and its investors, who would front the money to local governments to buy the loans, stand to reap big returns. The plan calls for homeowners to refinance for more than the governments paid for the mortgages. Investors would take a share of the higher refinance amounts. And MRP would make a $4,500 fee per transaction.
MRP’s plan is a strategy for "opportunistic investors to make a 20 to 30 percent profit" by "cherry pick(ing) the best loans out of a securitized pool and buying at a substantial discount," said Timothy Cameron, an executive with the Securities Industry and Financial Markets Association, which represents the mortgage-backed securities sector.
Lawyers for the association are challenging the proposal on constitutional grounds, arguing that it violates the Fifth Amendment’s takings clause, which allows eminent domain only for public use and only with just compensation.
However, outside experts, including several who expressed skepticism about the plan, said they doubted the opponents’ constitutional arguments would hold up under current case law.
The U.S. Supreme Court has allowed cities to seize many forms of property, including land to build roads and schools, intangible assets such as securities, and commodities such as hundreds of tons of black pepper during World War II.
And judges have granted lots of leeway to governments to decide which takings qualify as public uses, including those in which property is immediately handed over to other private parties.
In the 2005 case of Kelo v. City of New London, for example, the high court let the Connecticut city condemn residents’ homes so that the land could be transferred to private firms for redevelopment. The promised economic benefits, which never materialized, constituted a public use, the justices said.
Hudson Sangree at hsangreesacbee.com. For more stories visit scrippsnews.com