Any attempt by municipalities to use their powers of eminent domain to seize and purchase underwater loans out of private-label MBS will face “serious legal challenges” that will take years to litigate, according to a critic of government-backed mortgage programs.
“Since billions of dollars are at stake, the legality of this approach will be challenged by bond holders,” said Edward Pinto, a resident fellow at the America Enterprise Institute.
Three California municipalities are considering a plan to condemn underwater mortgages and purchase them at fair market value so the residents can be refinanced. The net effect will be a principal reduction for the borrowers. For the cities, it will presumably prevent foreclosures, further declines in properties values and blight.
Pinto says the seizing of mortgages is “more like grand theft mortgage than a silver bullet.”
He points out that the eminent domain approach targets performing loans—the bondholders’ most valuable loans—which amounts to “cherry picking.” And the plan assumes none of the loans will be paid off in full.
“The plan also appears to ignore the high transaction costs associated with eminent domain and mortgage lending—further diminishing its viability,” according to the AEI resident fellow.
If the courts uphold the use of eminent domain in taking mortgages, it would open the door for the cities to purchase the loans at “fair value.” But the valuation of those loans could be challenged by the bondholders, Pinto said. “Therefore, this issue will also be litigated long and hard.”
