Backlash bill would block eminent domain for underwater mortgages

Sept. 14, 2012

By Wayne Lusvardi

Will Americans be protected from eminent domain abuses? Eminent domain is where the government takes someone’s property, usually for a government purpose, such as building a school or road. But sometimes eminent domain is abused to take private property and give it to a private company, such as a big-box store or housing development.

Last week, California Lt. Gov. Gavin Newsom’s told mortgage banks and agencies of the federal government to “back off” from their opposition to the use of eminent domain in California to take “underwater mortgages.”

In response, on Sept. 13 Rep. John Campbell, R-Irvine, introduced the “Defending American Taxpayers from Abusive Government Takings Act” (H.R. 6397).  It would block local governments from pursuing the condemnation of so-called “underwater mortgages,” as is being proposed in San Bernardino County and elsewhere in California.

Campbell’s bill would work with secondary mortgage market lenders Fannie Mae and Freddie Mac, the Federal Housing Administration and the Veteran’s Administration to bring about mortgage reductions. The Federal Housing Finance Agency, overseer of both Fannie Mae and Freddie Mac, had threatened to take action against the use of what might be called “submerged eminent domain” before Rep. Campbell proposed his bill.

Underwater mortgages are really “over-mortgaged” loans where the amount of loan owed on a property is much higher than the current market value of a home.

For example, Campbell points out that San Bernardino County’s proposal would provide an incentive to appraise properties with underlying seized mortgages as low as possible to increase their potential profit to mortgage re-financiers. Stated differently: profiteering would be submerged out of the scrutiny of the public in rigged real estate appraisals.  What might be called “submergible eminent domain” would be used for underwater mortgages.

Campbell called such schemes “atrocious, corruptive, irresponsible and unconstitutional.”

Another Difficulty — A Tax Bill for Mortgage Reduction

The civil war over the use of eminent domain to acquire underwater mortgages has gotten almost all the media attention.  What has received less attention is the pending expiration of temporary federal legislation passed in 2007 that suspended the tax liability of homeowners who receive mortgage reductions of up to $2 million.

In 2007, Congress passed the Mortgage Forgiveness Debt Relief Act, which expires at the end of 2012.  There is discussion to extend it, but Congress only has three months to act.  Newsom has made no known advocacy to extend the Debt Relief Act.  Instead he is championing the questionable use of eminent domain law to buy out underwater mortgages.

Creative Appraisals Proposed In-Lieu of Eminent Domain

Steven Gluckstern, chairman of Mortgage Resolution Partners, a private hedge fund proposing to condemn underwater mortgages, has proposed another “doozey” of a concept.  It would involve using creative appraisals instead of eminent domain to reduce mortgages.  Here is the Sacramento Bee described an example of his:

“A homeowner paid $300,000 for a house during the boom. That house is now worth $200,000, with a mortgage balance much higher than that. A city would seize the mortgage and pay the note holder $160,000. Gluckstern contends that would be fair-market value, after the potential costs of foreclosing on the mortgage are deducted.”

“The idea is not for the city to become a lender. Instead, he said, the homeowner would refinance his mortgage at $190,000, with help from Mortgage Resolution Partners. The extra $30,000 would be split between investors, local government and MRP, which would make a flat fee of $4,500 per transaction.”

A representative of the Securities Industry and Financial Markets Association called the above-described proposal a scheme for “short-term opportunistic investors to make a 20-to-30 percent profit” by “cherry pick(ing) the best loans out of a securitized poor and buying at a substantial discount.”

Prominent eminent domain attorney Gideon Kanner on his blog on Aug. 17 said, in reaction to the creative appraisal concept:

“Nobody seems to be asking why the awesome sovereign government power of eminent domain should be enlisted in quest of quick private profit…the public interest must predominate and the private benefit is limited to being incidental to it, as the court explained in [the case] County of Los Angeles vs. Anthony.” 

Kanner also asked what public interest is served in the above refinancing example when the loan in question is that of a performing mortgage where payments are being made.

Kanner also noted that, once the Pandora’s Box of eminent domain is opened up for underwater mortgages, the property owners could not be denied hiring their own attorney and appraiser and contesting any mortgage buyout or reduction offer.  If they won in front of a jury, the local government agency would be on the hook to pay court costs and the property owner’s litigation and appraisal fees.  This is minimally about $50,000 per case.

There is No Underwater Mortgage Free Lunch

The use of so-called “submerged eminent domain” has become a trendy cause by media elites Arianna Huffington and actor John Cusack.  However, no mention has been made that, in San Bernardino County, the proposal to use eminent domain would call for about 80 percent of all property owners to vote for higher property taxes to pay off the underwater mortgages of the other 20 percent of homeowners.

How long the concept of using eminent domain to reduce “underwater mortgages” would remain popular when all homeowners in a designated area would have to vote for higher property taxes remains to be seen.