Threats of withdrawn mortgage credit may deter local governments from accepting proposals to seize underwater mortgages through eminent domain, not court rulings, according to one expert on the issue.
The actual process itself may not face huge legal hurdles.
"The legality is not an impediment to this program. Eminent domain is never popular. But the Supreme Court has very seldom, if ever, found local governments' use of eminent domain as unconstitutional," said Richard Friedman, managing attorney for Neal & Leroy, during a Source Media webinar for bond investors Thursday.
A group of private investors led by Mortgage Resolution Partners began pitching such a program to San Bernardino County, Calif. and other hard hit localities such as Chicago earlier in the year. The government would seize the mortgage with private dollars, and the investors would write down the principal before refinancing the loan into a new one backed by the Federal Housing Administration. Local residents in these areas and analysts voiced concern as county and city councils moved forward to consider the ideas earlier in the month.
John Vlahoplus, chief strategy officer and founder of MRP, told bond buyers during the webinar that the program would help hard hit municipalities, and concerns over investors receiving below market value of their loans are overblown.
"Every loan has its own value. Not everyone will be bought at 75% below value," Vlahoplus said.
He then taunted one of the investor trade groups opposing the program, the Securities Industry and Financial Markets Association.
"Who's right? The naysayers at SIFMA or the local governments? I can tell you right now SIFMA is wrong," Vlahoplus said.
Tim Cameron, managing director at SIFMA was also on the call. He declared the program "unconstitutional," but aside from the legal questions, he said it was simply bad policy. Cameron pointed out the Federal Housing Finance Agency threatened to keep the government-sponsored enterprises from financing loans in areas that enacted such a program.
Cameron promised "a multitude of costly legal challenges" for the local governments that implement the program. But reversing such decisions through the courts once seizing begins would prove very difficult, according to Friedman, who practices in Illinois and researched eminent domain case history in California.
"Nobody can safely quantify the unpredictable and hostile act of taking mortgages through eminent domain," Cameron said. "If you want to kill an economy, start by aggregating contracts and start by introducing eminent domain."
Cameron showed that some programs were having an effect on the negative equity problem in the U.S. Roughly one-third of all underwater loans received a modification and some with principal reduction so far, he said.
San Bernardino County is indeed starting to show signs of a turn around without the program, according to analytics firm Clear Capital.
Friedman pointed to several examples where eminent domain was used for the good of local economies, even in cases where land was seized to benefit private railroad companies or mills.
"Over the last 150 years, very, very rarely have the courts found (eminent domain) could not be exercised," Friedman said.