Officials in California and Chicago are throwing their weight behind a proposal that would let homeowners refinance certain loans.
What if there was a way to make eminent domain work for the little guy?
That's the idea being floated by Mortgage Resolution Partners, a California-based community advisory firm. The plan, currently under consideration in San Bernadino County and Chicago, is sort of deceptively simple. Right now, there are 14 million homeowners who are making payments on mortgages that are worth more than their home. In general, these loans are not controlled by individual banks, but rather by trusts.
MRP wants to let cities use eminent domain to take control of the mortgages. Here's how it would work: cities would condemn "underwater" homes that meet this criteria. Under the law, they would then pay mortgage holders (the trusts) only the "market value" of the home, or the value the house is worth today.*
Then, instead of booting the residents, the city would allow them to refinance their mortgage and pay a new, lower rate. This would reduce the principal the mortgage owners owe, saving them money that could, ostensibly, be spent on things like dishwashers and vacuum cleaners.
"What you do is you find a way for that mortgage to move from the trust to community," says MRP Executive Chairman Steven M. Gluckstern.
It's a clever idea. But is it legal? "It's very unusual," says Thomas W. Merrill, a law professor at Columbia University who specializes in property law. But, he notes, "this doesn't mean it's unconstitutional."
Before the landmark 2005 Kelo vs. New London decision, Merrill says, there's little doubt that the courts have upheld this kind of law. "Before Kelo, courts took a hands-off approach," Merrill says. In the 1984 case Hawaii Housing Authority vs. Midkiff, the Supreme Court ruled that the Hawaiian legislature could take a property controlled by landlords and sell it back to leasees. "Condemning a landlord's interest in property to transfer to a tenant is not too different," Merrill says.
But Kelo changed that. In that case, the Supreme Court ruled that cities could use eminent domain to transfer land from one private owner to another, and that doing so for economic development purposes constitutes a public use. "At this point, I guess you'd have to say all bets are off in terms of what is and isn't eminent domain," Merrill says.
The MRP proposal leaves open two key questions. First, would cities pay a property rate that courts deem fair? And does refinancing loans count as a "public use"?
Traditionally, the courts have defined "fair market value" or "just compensation" as what the buyer and seller would agree to in the marketplace for the property.
But there are of course opponents, like the Securities Industry and Financial Markets Association and the American Securitization Forum. Both are trade groups that represent mortgage-holding trusts that stand to lose money if the measure is passed.
A memo written by their lawyers argues that "fair market value" should be based on the value of the loan owned by the trust, not the value of the property securing that loan. "The fair market value of a loan necessarily focuses on the value of the loan, not simply on the value of the home that secures it," they write. "The notes at issue are likely worth close to the present value of their outstanding balance and the sum of anticipated interest payments—not the current value of the underlying properties pledged as security."
Then, there's the question of whether this is a public use. In Kelo, the Supreme Court held that condemning property to promote economic development can constitute a public use.
In that case, the court upheld eminent domain as part of a broader economic development plan that was "integrated" into the city’s urban development plan and had concrete benefits, like job creation. Proponents argue that that's true of this plan too — neighborhoods would keep their residents, and struggling homeowners would have more money to pour into the economy.
But lawyers for the trusts are decidedly less sure. They write:
Here the public benefits would be incidental and attenuated, if indeed they exist at all. Notably, the MRP proposal specifically is not addressed to defaulted or even delinquent loans, where the property at issue might be subject to a present or imminent threat of blight. The proposal instead is limited to performing loans—those much less likely ever to default—on the theory that forcibly transferring and discounting them now will reduce the risk that they could default and lead to future blight.
Even if these eminent domain measures are passed, they will likely be mired in years of legal wrangling before they could ever take effect. In their legal memo [PDF] against the plan, lawyers at O'Melveny and Meyers basically threaten as much, writing that "at a minimum, it is almost certain to be tied up for years in litigation." And that's not all. The very act of introducing this measure would do more harm than good, they argue, "exposing the government entities to enormous transaction costs, potentially including opposing counsel’s fees if the challenge is successful."
* This sentence has been changed to clarify who the cities would pay to gain control of the properties.