Eminent Domain of Mortgage Securities: The Other Side

In our continuing coverage of Mortgage Resolution Partners’ (MRP) effort to facilitate local governments’ use of eminent domain to stem the mortgage crisis, today we present the other side—specifically, the comments submitted to the Federal Housing Finance Agency (FHFA) by the American Securitization Forum (ASF) on September 7.  The ASF is a professional forum with over 330 members, including issuers, investors, servicers, ratings agencies, and other professional organizations involved in securitization transactions.

We have previously described MRP’s plan here and here. In general, MRP is advocating that local governments use eminent domain to seize and restructure private-label underwater mortgages. These repackaged loans would ultimately be resold to investors with the value set at the current market value of the underlying property. This proposal has sparked controversy in terms of both its affect on the mortgage market and its constitutionality.  Not surprisingly, ASF argues that the plan will negatively impact the mortgage market and is unconstitutional.

[Update: Click through to read the rest of the article and a comment from Bill Falik challenging the accuracy of ASF’s statements]

In its comments to the FHFA, ASF first argues that the plan would not alleviate the foreclosure crisis because the plan only involves seizure of performing loans. While much of the blight, argues ASF, results from nonperforming or high-risk loans, MRP’s proposal includes only performing underwater mortgages. Thus, “ MRP’s plan addresses the wrong mortgage loans,” says ASF.

ASF also argues that both lenders and investors likely will respond to this new seizure risk by increasing the cost of borrowing. Most lenders, says ASF, will either require a reduced loan-to-value ratio for new borrowers or choose not to service areas where eminent domain has been implemented. Additionally, “investors in mortgage loans may refuse to invest in mortgage loans that could be acquired through the exercise of eminent domain,” says ASF.

ASF also argues that the proposal is unconstitutional because it does not comply with the requirement that a taking using eminent domain be for “public use.” While the Supreme Court held in Kelo that public use could encompass comprehensive economic development, ASF argues that by focusing on only performing loans, the plan will not remedy current blight.  Rather, ASF argues that most of the plan’s benefits will accrue to MRP and its investors. These private benefits, however, are not a sufficient public use, says ASF.

Even if there is a valid public use, ASF argues that because the mortgage loans are held by securitization trusts outside the local municipality, local governments lack the power to seize the property.  The California Code of Civil Procedure limits local government ‘s use of eminent domain to seizure of property “within its territorial limits.” While proponents argue that the plan is within this definition because the underlying properties are within the territorial limits, ASF argues that because the mortgage notes are held elsewhere, local governments would be overstepping the law.

Cornell University Law School Professor Robert C. Hockett responds to these arguments and more in his remarks on a panel for “The Housing Crisis and Policy Solutions: Should Eminent Domain Be Used to Save Underwater Homeowners?”