Thursday, January 3, 2013

Taking Title: the Legal Logic Behind Municipal Proposals to Use ...

The Great Workout begun in 2008 grinds on, and resolution of large numbers of underwater mortgages continues to be controversial.? Deleterious effects of underwater mortgages and mass-foreclosure on communities where they are concentrated has been widely reported, and the efficacy of private, loan-by-loan bankruptcy, foreclosure and workout solutions has been criticized, yet no consensus has emerged around a large-scale restructuring solution.? Dissatisfaction with the pace of addressing this problem has led to proposals out of academia and in particular communities to use eminent domain to seize and restructure these mortgages.? But can the power of eminent domain be exercised to seize, not a physical property, but a financial instrument?

The most prominent proponent of using eminent domain to restructure underwater mortgages is Professor Robert C. Hockett of Cornell University, who has proposed using eminent domain to purchase and restructure these loans in an article detailing one such proposal for San Bernardino County in California.? You can see a commentary on his proposal by Yale economist Robert J. Schiller in The New York Times here.? Proposals such as Professor Hockett?s involve condemnation and purchase of the mortgage loans themselves, but not the houses that secure them, by municipalities, either on their own or in partnership with private investors or other municipalities.? The owner of the condemned mortgage receives ?just compensation? for the mortgage, but loses its ownership interest.? The mortgage is then written down to a level where the homeowner can pay it off with a refinanced loan, or written down and held by the municipality.?San Bernardino County, joining with several other cities, has created a Joint Powers Authority to investigate, oversee and implement such a program.? Chicago also has considered such a use of eminent domain.

The legal justifications offered for these proposals do not include any particularly special application of eminent domain.? Professor Hockett?s article provides an overview of eminent domain and its application to government seizures of properties other than land, with some authority dating to 1625.? Eminent domain is a government?s right to use, or even alienate or destroy, private property for the public good, so long as the government offers just compensation to the owner.? Its application is not limited to particular forms of property, and, in our federal system, this power may be applied by either the federal government, the states, or, if the power is delegated by the states, by municipalities.? Professor Hockett argues that, given the substantial negative effects on localities of large numbers of homeowners being obligated on underwater mortgages, the exercise of eminent domain by municipalities is a valid exercise of municipal police power.? Given that, through the securitized mortgage market, debt holders nationwide may hold ownership interests in mortgages a municipality seeks to condemn, however, one might question whether states and municipalities have jurisdiction to exercise that police power against out of state entities to condemn property rights and whether such a power should be exercisable by the federal government only.? Professor Hockett argues that established doctrines of due process and jurisdiction have long provided mechanisms for states to exercise jurisdiction over mortgage debts.? The arguments for and against the constitutional validity of such a use of eminent domain are beyond the scope of this entry, however.

One can think of numerous disturbing applications for an eminent domain power to condemn forms of property other than real property.? While the just compensation requirement will check many abuses, there is also bound to be tremendous political resistance to resolving public problems through the use of this extraordinary power.? In fact, just this sort of resistance has emerged in response to these proposals.? A bill pending in the House of Representatives would penalize municipalities exercising a power of eminent domain to condemn mortgages by forbidding certain government and government-sponsored entities from purchasing, insuring and guaranteeing mortgages in municipalities that have used the power.? Last year, the Federal Housing Finance Agency, the overseer for Fannie Mae and Freddie Mac, solicited comments (which you can see here) on how to address proposals to use eminent domain to condemn mortgages, citing, among other concerns, constitutional, consumer protection, valuation, credit market and implementation concerns.? Moreover, the financial services industry has the ability to choose not to lend money in localities with laws or practices judged to increase credit risk, and, industry groups, such as SIFMA, have been active in opposing eminent domain proposals.

All of these actions have the potential to lessen access to credit for new buyers in these markets, make refinancing harder, depress prices, and therefore inflict exactly the kinds of damage that the condemnation programs are trying to fix.? It remains to be seen whether municipalities will decide that local economic damage from underwater mortgages, or from a drip, drip, drip of residential foreclosures is severe enough to proceed in the face of these pressures, as well as any litigation challenging these uses of eminent domain.? Similarly, a municipal threat of using eminent domain may speed the response by other actors to address underwater mortgages in particular localities, either through speedier foreclosures or loan restructuring, allowing the issue to discretely slip away.

Robert C. Hockett, It Takes a Village: Municipal Condemnation Proceedings and Public/Private Partnerships for Mortgage Loan Modification, Value Preservation, and Economic Recovery, Cornell Law School, Legal Studies Research Paper Series, Paper No. 12-12, available at ssrn.com/abstract=2038029

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Source: http://business-finance-restructuring.weil.com/secured-claims/taking-title-the-legal-logic-behind-municipal-proposals-to-use-eminent-domain-to-seize-underwater-mortgages/

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