Foreclosure Rescue by Eminent Domain Gets a Second Look

by 18 Feb 2013

One of the most interesting proposals to help hopeless homeowners that are deeply underwater on their outstanding mortgages consists of the use of the eminent domain doctrine of property possession for the public good. Such a move was seriously considered by San Bernardino County officials in California last year before it was foregone in early 2013.

The plan is decidedly controversial: County officials concerned about the abandonment and blight of their neighborhoods due to foreclosure would exercise eminent domain on properties facing foreclosure with the financial backing of Mortgage Resolution Partners, an investment firm. The bank pursuing the foreclosure would get fair market value for the home, the borrowers would get a favorable refinance that they could not have otherwise afforded, and the lost of a property to blight would be averted.

The legal standing of this proposal was vetted by a law professor at Cornell University. It seemed legally feasible and even noble, but San Bernardino dropped it due to the potential civil and even constitutional challenges it would face. Other municipalities are still entertaining the idea in light of the pesky foreclosure rate that still affects them; but, with a housing market on the rebound, economists from the Federal Reserve Bank of New York are looking at the fiscal aspects of the proposal.

Eminent Domain Versus Market Forces

At this time, the situation in San Bernardino has vastly improved from a few years ago. The number of mortgages that are not backed by the FHA, Fannie Mae or Freddie Mac is small, and about a quarter of all those home loans originated at the height of the housing bubble have already foreclosed. More than 300,000 of those mortgages are still in trouble, which could mean a lot of blight for San Bernardino.

A lot has happened to those underwater homes in San Bernardino since around February 2012. Home prices in that housing market have appreciated, and a few borrowers have been able to convince their lenders to modify their mortgages. Perhaps it was the threat of eminent domain that did the trick, but it could be safely assumed that banks are not all that interested in keeping their Real Estate Owned (REO) portfolios full. They are not crazy about letting go of properties at current market prices through the process of eminent domain, particularly at a time when things are looking up for the housing market.

In terms of cost-benefit ratios, San Bernardino County may avert blight without resorting to eminent domain if the housing market continues to improve. Market forces may be more cost-efficient in pulling mortgage borrowers up from the depths of negative equity, but that is still contingent upon appreciation and speculation.



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