Four years after a financial meltdown that nearly wrecked the U.S. economy and three years after the official end of America's Great Recession, most experts point to the "overhang" of distressed properties in the housing market as a chief reason that the economy is rebounding so slowly. Included in that group is Federal Reserve Chairman Ben Bernanke. More than one in five mortgaged homeowners – an estimated 16 million nationwide – are "underwater," meaning, collectively, they owe $1.2 trillion more on their homes than their houses are worth. Nearly three million homes are in default and on their way to foreclosure. In short, the country seems locked in an incessant and self-amplifying cycle of decreased consumer spending, failing businesses, decimated communities, shrinking tax bases and deferred investment. The problem so far has eluded both government and bank-driven solutions. The federal Home Affordable Mortgage Program, created in 2009, has reached only a small percentage of the borrowers it was designed to aid. And the $10 billion that the country's five biggest banks said they would offer in loan forgiveness as part of a $25 billion settlement reached between them, the federal government, and 49 states to settle allegations that banks mishandled mortgages, is trickling out slowly. For new problems, however, old solutions sometimes arise. Could this be another? Into the housing void comes a San Francisco-based investment fund, Mortgage Resolution Partners, proposing a new idea grounded on an old concept – eminent domain. Eminent domain is the power of a municipality to take private property needed for the public good, as long as the owner is compensated at fair-market value. Over the years, governments have used eminent domain authority to seize land to build highways, bridges and other public works projects – or to clear blighted urban areas. Courts consistently have maintained that the power of eminent domain can apply to tangible property such as land and personal goods as well as to intangible property such as loans and contracts, as long as the municipality is acting to further a public purpose. Eminent domain never has been used to condemn mortgages held by private investors or financial institutions. But that's the plan now being considered by several local governments across the country that were approached by Mortgage Resolution Partners. They include Sacramento, and Berkeley in California; Las Vegas, Nevada; Chicago, Illinois; and Detroit, Michigan. These are all communities with large numbers of foreclosed homes and underwater borrowers. Also considering Mortgage Resolution Partners' proposal is the San Bernardino County in California, a municipality that sits smack in the middle of one of the country's most severely affected housing markets: Out of 317,000 mortgages in the county, about 150,000 are underwater. Here's how the program would work: San Bernardino County would "condemn" a certain class of underwater, delinquent or defaulted mortgages – those that have been securitized and are privately held by large, institutional investment trusts and thousands of individual investors but which have lost some of their value and have either failed or are in the greatest danger of failing. This category of loans is particularly immune to modification. Why? Because the securitization process has sliced and diced them among so many different owners and they often can't be resold because their trust agreements do not allow for voluntary sales. Private money raised by Mortgage Resolution Partners would pay the owners of these condemned loans their current, fair-market value, in the name of the county. That, in effect, would force the sale, cancelling the original contracts and locking in what were only paper losses. San Bernardino would then forgive underwater homeowners all of their debt in excess of what their homes are now worth. The company would then work with the homeowners and the county to restructure new, federally-backed loans at lower rates, which can be sold to another group of institutional investors with the proceeds paying back the original lenders who financed the eminent domain buyout. The company sees this as a win-win situation:
- Homeowners get to stay in their homes, protect their equity and lower their monthly mortgage payments.
- Governments help prevent additional defaults from flooding the local housing market with more foreclosed homes while halting blight and keeping their tax rolls healthy.
- The original owners of the underwater loans get at least some return on their investments.
- The new loan investors get to hold less risky mortgages that will eventually pay them a fair rate of return.
- And Mortgage Resolution Partners receives a flat fee ($4,500) for each mortgage the county condemns.
Naturally, there is opposition. The Securities Industry and Financial Markets Association (SIFMA) and two dozen other trade organizations decry the move as an unconstitutional encroachment on free enterprise and the sanctity of contracts, and warn that lenders will be less likely to extend credit in any community where eminent domain may be a threat to seize mortgages sometime in the future. These groups also suggest that legal challenges would be forthcoming. Some politicians are skeptical. (Shocking, I know.) Others are fighting back. Congressman John Campbell, (R-Irvine) introduced federal legislation aimed at blocking the use of eminent domain by local governments by prohibiting the nation's four biggest mortgage lenders – Fannie Mae, Freddie Mac, the Federal Housing Administration and the Department of Veterans Affairs – from buying or backing loans in municipalities that use eminent domain to condemn underwater loans. As of today, no local government has bought into the plan officially. All eyes are on San Bernardino County CEO Greg Devereaux to see what he is going to do. But because the city of San Bernardino itself has an unemployment rate of 15.7 percent and filed for bankruptcy this past August, Devereaux and his government colleagues may be running out of time and options. Some feel the same way about the housing crisis nationally. If this is not the magic button, what is? Without addressing this continually troubled segment of the nation's economy, i.e. the housing "mess," the country's nascent recovery will continue to limp along. If the use of eminent domain can forestall mass foreclosures, prevent cities and communities from imploding and keep homeowners in their homes, now may be the time to think of it - not as a foul practice employed by demonic governments - but instead as a weapon in the fight for American's economic revival. Al Krulik writes about personal finance issues for Debt.org.