New Strategy for Underwater Mortgages Would Use Government Powers of Eminent Domain

The Wall Street Journal reports on a new approach to refinancing underwater home mortgage loans that involves municipalities using their powers of eminent domain to seize mortgages from lenders. The loans would then be refinanced through a federal loan program. The proposal, being pitched to municipalities by advisory firm Mortgage Resolution Partners, could generate returns to investors of up to 30% and billions of dollars in fees for bankers, according to the Journal article. Under the proposal, the municipalities would seize underwater but performing home mortgage loans that have been securitized, paying prices up to 25% below the appraised value of the homes. The homes would then be refinanced at close to 98% of their value, with the difference going to pay transaction costs, the advisory firm's fees and a healthy return to investors. The proposal has come under fire from financial trade groups who believe it doesn't satisfy the public use requirement of eminent domain. “The U.S. Constitution’s eminent domain powers were not intended for the cherry-picking of performing loans to create exorbitant profits for private investment funds like MRP,” Tom Deutsch, executive director of the American Securitization Forum told the Journal. Critics also argue that the program could have unintended consequences such as increasing the cost of credit and worsening the housing crisis rather than improving it. Bondholders are understandably concerned that they will be forced to sell to municipalities at a steep discount. Indeed, it is unclear how the proposal would be justified under the doctrine of eminent domain, which in addition to requiring a public purpose, would also mandate that the bondholders receive "just compensation", generally interpreted as fair market value. Proponents of the plan presumably must demonstrate that the fair market value of the mortgages -- which would be performing -- is equal to only 75% of the value of the collateral that secures them.