Imagine your local government replacing the negative equity in your home with a mortgage that is more in line with its fair market value. Is this even possible? It depends on whom you ask.
Proponents of the idea believe that the use of eminent domain to seize and restructure underwater mortgages will encourage borrowers to stay in their homes and eventually eliminate the devastating effects of blight in local communities. Opponents believe it will cause a cessation of lending in areas subject to eminent domain and cripple those local economies. This article will discuss U.S. Supreme Court precedent, local government initiatives, and industry responses relating to the use of eminent domain to restructure mortgage loans.
U.S. Supreme Court Sets the Stage: Kelo, Midkiff, and Berman
Suzette Kelo enjoyed the view from her pink beach cottage. From the time she first saw it, she knew she would buy it. Life had not been easy for Suzette. Finally, after two husbands and five grown sons, this house was her new start. She purchased it for $53,500. Built in the 1890s, it was in desperate need of a paint job. The neighborhood wasn’t all that great. But it was what she could afford. With paint and hard work, she turned the ugly duckling into a charming pink cottage with a fascinating waterfront view. Unbeknownst to Suzette, however, a major pharmaceutical company and a handful of local government officials also could see the potential in her waterfront neighborhood. Less than two years after purchasing the property, Suzette received a letter informing her that her home would be demolished to make way for a new pharmaceutical research complex along with a hotel, eateries, and shops. After she refused to sell her home, the city began condemnation proceedings. Suzette and her neighbors sued the city, and her case landed squarely in the U.S. Supreme Court. See Jeff Benedict, Little Pink House: A True Story of Defiance and Courage (2009).
The issue before the Court in Kelo v. City of New London, 545 U.S. 469 (2005), was whether the city’s use of eminent domain to condemn private properties qualified as a “public use” within the meaning of the Takings Clause of the Fifth Amendment to the Constitution, which states, “nor shall private property be taken for public use, without just compensation.” U.S. Const. amend. V. “That Clause is made applicable to the States by the Fourteenth Amendment.” Kelo, 545 U.S. at 472 n.1 (quoting Chicago, B. & Q. R. Co. v. Chicago, 166 U.S. 226 (1897)).
With a 5 to 4 majority, the Court held the city’s proposed condemnations were for a “public use” within the meaning of the Fifth Amendment. In reaching this decision, the Court found two state statutes instructive:
Conn. Gen. Stat. § 8-193(b)(1)—The development agency may, with the approval of the legislative body in accordance with this subsection, and in the name of the municipality, acquire by eminent domain real property located within the project area and real property and interests therein for rights-of-way and other easements to and from the project area, in the same manner that a redevelopment agency may acquire real property under sections 8-128 to 8-133, inclusive, as if said sections specifically applied to development agencies, except that no real property may be acquired by eminent domain pursuant to this subsection for the primary purpose of increasing local tax revenue. [Emphasis added.]
Conn. Gen. Stat. § 8-186—It is found and declared that the economic welfare of the state depends upon the continued growth of industry and business within the state; that the acquisition and improvement of unified land and water areas and vacated commercial plants to meet the needs of industry and business should be in accordance with local, regional and state planning objectives; that such acquisition and improvement often cannot be accomplished through the ordinary operations of private enterprise at competitive rates of progress and economies of cost; that permitting and assisting municipalities to acquire and improve unified land and water areas and to acquire and improve or demolish vacated commercial plants for industrial and business purposes and, in distressed municipalities, to lend funds to businesses and industries within a project area in accordance with such planning objectives are public uses and purposes for which public moneys may be expended; and that the necessity in the public interest for the provisions of this chapter is hereby declared as a matter of legislative determination. [Emphasis added.]
The Court rejected the petitioner’s argument that the city should be required to demonstrate with “‘reasonable certainty” that the expected public benefits [resulting from the condemnation] w[ould] actually accrue.” Instead, the Court deferred to legislative judgment. Id. at 487−88. “When the legislature’s purpose is legitimate and its means are not irrational, our cases make clear that empirical debates over the wisdom of takings . . . are not to be carried out in the federal courts.” Id. at 488 (quoting Hawaii Hous. Auth. v. Midkiff, 467 U.S. 229, 242−43 (1984)). The Kelo majority further reaffirmed that a state’s immediate transfer of condemned property to private individuals does not necessarily diminish the public character of the taking and that the purpose of a taking is the controlling factor in the determination of its public character. Id. at 480−81 (citing Berman v. Parker, 348 U.S. 26, 33 (1954)).
Kelo caused a sweeping controversy across the country and had a chilling effect on local government initiatives to exercise their eminent domain powers. State legislators began to call for revision of vague, or otherwise weak, eminent domain statutes to insert additional consumer protections and due process. According to the National Conference of State Legislatures:
Forty-two states . . . enacted legislation or passed ballot measures during 2005−2011 in response to the Kelo decision. The laws and ballot measures generally fall into the following categories:
- Restricting the use of eminent domain for economic development, enhancing tax revenue or transferring private property to another private entity (or primarily for those purposes).
- Defining what constitutes public use.
- Establishing additional criteria for designating blighted areas subject to eminent domain.
- Strengthening public notice, public hearing and landowner negotiation criteria, and requiring local government approval before condemning property.
- Requiring compensation at greater than fair market value.
See Nat’l Conference of State Legislatures, Eminent Domain Overview (2013), www.ncsl.org/issues-research/envres/ eminent-domain-overview.aspx.
Two years after Kelo, however, the subprime mortgage crisis riveted the country and crippled the U.S. economy, resulting in record foreclosures, blighted properties, and investor losses on mortgage-backed securities. Among several proposals to restore the housing market was the idea that local governments could use the power of eminent domain to condemn existing mortgage loans.
Using Eminent Domain to Condemn Underwater Mortgages: The San Bernardino Experiment
Although the U.S. Supreme Court has not held that a local government can exercise its eminent domain powers to condemn mortgage loans, the Court’s precedents make it clear that state legislative purposes and statutes will be the starting point for any such analysis. The stage is set. Enter the players.
Proponents of using eminent domain to take mortgage loans are advancing the idea that local governments, empowered by state law, can align themselves with applicable U.S. Supreme Court precedent by (1) invoking their eminent domain statutes, (2) stating a purpose that fits the definition of “public purpose” and thus “public use” by the Court, and (3) claiming that the use of eminent domain powers extends to intangible property such as mortgage loan contracts. “Under California law, for instance, a city may only take land for economic development purposes in blighted areas.” Kelo, 545 U.S. at 489 n.23; see also Cal. Health & Safety Code Ann. §§ 33030−33037. The revitalization of blighted communities is a recognized “public purpose.” Berman v. Parker, 348 U.S. 26, 33 (1954).
San Bernardino County, California, was one of those areas hardest hit by the subprime crisis, with 44% of the county’s mortgage loans underwater as of the fourth quarter of 2012. Only 10% of these loans are delinquent, meaning an overwhelming number of taxpayers in San Bernardino County are making mortgage loan payments on homes that are worth significantly less than when they purchased them. Yet, the prevention of blight is a true concern for the county. Last year, the city of San Bernardino filed a petition for bankruptcy stating that it had more than $1 billion in debts. For statistics, see The U.S. Housing Crisis: Where Are Home Loans Underwater?, Zillow, www.zillow.com/visuals/neg ative-equity/#7/34.841/-116.175 (last visited Apr. 30, 2013). An overwhelming number of taxpayers in San Bernardino County are making mortgage loan payments on homes that are worth significantly less than when they purchased them.
Player 2, and one of the most active proponents of the eminent domain theory, is Mortgage Resolution Partners, which describes itself as “a Community Advisory firm working to stabilize local housing markets and economies by keeping as many homeowners with underwater mortgages in their homes as possible.” See Mortgage Resolution Partners, http://mortgageresolution.com. Essentially, the plan works as follows: (1) Mortgage Resolution Partners obtains investor financing for the local government; (2) the local government condemns the mortgage loan and forces a short payoff to the mortgage lender; (3) the investors acquire the interest in the mortgage loan and restructure the loan by reducing the principal balance; and (4) the loan is refinanced to an amount lower than the fair market value of the property. Mortgage Resolution Partners would receive a standard fee per condemned mortgage loan.
Early in 2012, Mortgage Resolution Partners proposed its plan to Greg Devereaux, chief executive officer of San Bernardino County. Shortly thereafter, San Bernardino County and two neighboring cities agreed to form the Homeownership Protection Program Joint Powers Authority (JPA), tasked with exploring the development of a program to assist homeowners with underwater mortgages. See First Amended and Restated Joint Exercise of Powers Agreement, Homeownership Protection Program (June 19, 2012), www.homeownershipjpa.org/Portals/ 18/Documents/Agreement.pdf.
Players 3 and 4
From its implementation the JPA was shrouded in controversy. Almost immediately—in part because of a “cover-up” story published in a local newspaper—protests ensued on the ground that the JPA was established with the intent to pursue an eminent domain remedy but did not disclose its agenda in its formation documents or to the public. At the first meeting of the JPA, both the public and industry representatives appeared to state their objections to the county’s use of eminent domain to seize mortgage loans. See Andrew Edwards, DailyBulletin: New San Bernardino County Agency Created to Fight Foreclosures Holds First Meeting, Attracts Criticism, InlandPolitics.com (July 13, 2012), http://inlandpolitics.com/blog/2012/07/14/dailybulletin-new-san-bernardino-county-agency-created-to-fight-foreclosures-holds-first-meeting-attracts-criticism.
On January 24, 2013, after several months of industry and media attention, the JPA decided not to pursue eminent domain as a solution to underwater mortgages in San Bernardino County. “It’s wrong to impose that risk on the community without support from the community, and that level of support has not materialized,” said Board Chair Greg Devereaux. Press Release, Homeownership Protection Program Joint Powers Authority, JPA Declines to Consider Eminent Domain Proposals (Jan. 24, 2013), available at www.sbcounty.gov/uploads/cao/press releases/content/JPA_RFQ_PR_1-24-13.pdf#.UQGMq5AtXpI.twitter. There can be no doubt that in reaching this conclusion, JPA considered industry responses opposing the plan.
Industry Response to the Use of Eminent Domain for Mortgage Loans
Real estate brokers, mortgage lenders, and securities professionals were instrumental in articulating the various concerns with the use of eminent domain to seize underwater mortgage balances. Some indicated it would freeze the credit markets in affected areas because lenders would refuse to lend. Others argued it violated the Contracts Clause of the U.S. Constitution and, because the takings would benefit private investors, it would not be for a public purpose under the Fifth Amendment to the U.S. Constitution. The Securities Industry and Financial Markets Association (SIFMA) actually attended at least one public meeting.
Most notably, the San Bernardino controversy garnered the attention of the Federal Housing Finance Authority (FHFA), which oversees the Federal National Mortgage Association (Fannie Mae) and the Federal Home Mortgage Loan Corporation (Freddie Mac). Without any specific mention of the controversy in San Bernardino, the FHFA published a notice in the Federal Register entitled “Use of Eminent Domain to Restructure Performing Loans” on August 9, 2012. Use of Eminent Domain to Restructure Performing Loans, 77 Fed. Reg. 47,652 (proposed Aug. 9, 2012). In the notice, the FHFA expressed “significant concerns” with the use of eminent domain to revise existing financial contracts. See id.
Without stating what specific actions it would take, the FHFA determined that some action might be necessary on its part as a conservator for Fannie Mae and Freddie Mac and as a regulator for banks to avoid a risk to safe and sound operations and to avoid taxpayer expense. See id. Among the questions raised by the FHFA were
the constitutionality of such use [of eminent domain]; the application of federal and state consumer protection laws; the effects on holders of existing securities; the effect on millions of negotiated and performing mortgage contracts; the role of courts in administering or overseeing such a program, including available judicial resources; fees and costs attendant to such programs; and, in particular, critical issues surrounding the valuation by local governments of complex contractual arrangements that are traded in national and international markets.
Comments were solicited from the industry on how to move forward with a proposed action. To date, the FHFA has received several comment letters, which can be obtained from the FHFA’s web site at www.FHFA.gov.
Although the industry has spoken, and the San Bernardino effort has ended, there is no sign that the proponents’ resolve to use eminent domain to condemn mortgage loans is cooling. In a Los Angeles Times article, the chair of Mortgage Resolution Partners was reported to be in talks with more than 30 jurisdictions across the country and was confident that one of them would implement his plan in 2013. See Alejandro Lazo, San Bernardino County Abandons Eminent Domain Mortgage Plan, L.A. Times (Jan. 24, 2013), www.latimes.com/business/money/la-fi-mo-eminent-domain-20130124,0,4577228.story. On Tuesday, April 2, 2013, the City Council of Richmond, California, approved
an Advisory Services Agreement with Mortgage Resolution Partners, LLC to assist the City of Richmond in reducing the impact of the mortgage crisis, by advising on the acquisition of mortgage loans through the use of eminent domain, in order to restructure or refinance the loans and thereby preserving home ownership, restoring homeowner equity and stabilizing the communities’ housing market and economy by allowing many homeowners to remain in their homes.
City Council Agenda, Richmond, Cal., Apr. 2, 2013, available at www.ci.richmond.ca.us/archives/30/Apr2 agenda.pdf.
At least for now, the debate remains alive and well.
Aftermath of Kelo Decision
In 2007, Suzette’s little pink house was disassembled and moved to another area in the city where it was designated with a historical marker. Ms. Kelo settled with the city for $442,000. She used half of the cash to buy another home directly across the river from the city where she had lived: a little house, on a hill, next to the water. See Benedict, supra.
The city of New London’s proposed development never came to complete fruition. Although the pharmaceutical company built its complex, they vacated it in 2009 with a loss of 1,400 jobs and hundreds of millions of dollars to the city.
The aftermath of Kelo is a stark reminder that, although there may be public interest in solving the effects of the mortgage crisis in communities, local governments should take care to ensure that more harm is not created in an attempt to achieve the greater good.
What Happens Next?
Although it can be said that decisions such as Kelo opened the door for local governments to claim the power to use eminent domain to take mortgage loans, the cases are certainly not dispositive of the issue. Irrespective of the results, the use of eminent domain to take mortgage loans will most likely first require approval by the court of public opinion, which, so far, overwhelmingly rejects the idea as an indecent proposal. Depending on the circumstances, however, that opinion is certainly subject to change.
What happens next? Who knows? What we can be sure of is this: the first locality that attempts to use eminent domain to take mortgage loans will be swiftly met with legal challenges that may very well make this issue the next eminent domain matter to be taken up by the U.S. Supreme Court. Stay tuned.