Eminent Domain and the Underwater Mortgage
A number of cities in New Jersey, including Irvington and Newark, are considering using the power of eminent domain to aid homeowners whose mortgages are underwater. A mortgage is underwater when its unpaid balance is greater than the property’s market value. The underlying mortgages, however, are not necessarily in default.
The concept of using eminent domain to assist homeowners in danger of foreclosure was first introduced in San Bernardino, California when the County explored the idea of addressing negative equity by using private equity to help current borrowers in foreclosure blighted neighborhoods. The controversial plan was for municipalities to use the power of eminent domain to circumvent mortgage contracts, acquire loans from bondholders, write them down, and give them back to the bondholders. The proposal was abandoned by the County and two of its cities because of the unquantifiable risk that it introduced to the market and the lack of public support. The level of risk involved, the possible cost of implementing such a plan, pushback from the mortgage industry, and the threat of serious litigation have proven significant impediments to cause a number of cities to reject the idea of using eminent domain as a cure-all to the woes of the housing market.
Officials of other cities still find the possibilities of the plan appealing in theory, if not in practice.
“It's designed to prevent foreclosures, keep people in their homes, stabilize our neighborhoods and give our local economy a chance to recover,” said Gayle McLaughlin, mayor of Richmond California.
Richmond has adopted a plan to use eminent domain to seize underwater mortgages, but has yet to actually use the power. The city’s hesitation may be attributable to a forewarning of future litigation as a law suit that was preemptively filed by Bank of New York Mellon and Wilmington Trust Co. was dismissed by the court in September as premature. See Order Granting Motion to Dismiss, Bank of New York Mellon v. Richmond, California (Nov. 6, 2013). The Federal Housing Finance Agency has also threatened legal action against cities that use eminent domain in this way. FHFA has called it “a clear threat to the safe and sound operations” of the mortgage industry. The Mortgage Bankers Association, asset managers as well as groups representing banks, real-estate agents, and builders have also objected to the plan, saying it would deter investments in mortgages and damage communities by having a chilling effect on the extension of credit to prospective homeowners. The financial industry views eminent domain as a slippery slope because it penalizes those who save and invest, and violates the rights of investors who may not receive the fair market value of the mortgage.
Undeterred, officials and activists in Irvington, Newark, and other cities are championing the use of eminent domain to seize underwater mortgages as “friendly condemnations” and using incentives to persuade homeowners to agree to the use of the power of eminent domain to prevent foreclosures in the struggling cities. Activists insist that New Jersey is in a state of crisis. While foreclosure rates are falling in other parts of the country, New Jersey is on track for another 50,000 filings before the end of 2014. More than 50 percent of Newark and Elizabeth mortgages are underwater, trailing only Hartford, Connecticut among cities with more than 100,000 residents. Paterson is fourth at 49 percent, just ahead of Detroit. Jersey City ranks 32nd in the nation according to the report “Underwater America” completed by a team of urban planners and sociologists from numerous academic institutions.
Although the New Jersey American Civil Liberties Union has traditionally been wary of the use of the power of eminent domain, executive director Udi Ofer has voiced support for the proposal and his belief that the use of eminent domain to purchase underwater mortgages would be permitted under New Jersey law. The ACLU joined officials from Newark, Irvington, and other cities in requesting that U.S. Attorney General Eric Holder investigate possible retribution from the Securities Industry and Financial Markets Association (SIFMA) and other major banks against communities that choose to use “eminent domain” to seize mortgages in foreclosure.The Home Defenders League has also announced its support for the proposal. Members of the Irvington NAACP have stated that their hope that “Eminent domain can work for Irvington” is spurred by the fact that an estimated 1,775 homes in Irvington have been foreclosed upon since 2008, leading the city to spend revenue maintaining and policing vacant and abandoned properties. Facing similar problems, Chicago, Illinois and Yonkers, New York are also debating the idea.
In March, Irvington council members approved a resolution which brings the issue before the Planning Board for identification of properties in potential foreclosure in areas in need of redevelopment. Authorities estimate that approximately 200 underwater mortgages will meet the criteria to be taken by the township. In May, the Newark Municipal Council unanimously approved a resolution in support of the city purchasing underwater mortgages. It has been estimated that approximately 1,200 homeowners in Newark will be saved from foreclosure if action is taken. However, there is no assurance that these mortgages will be paid and it is unclear whose money will be at work when the mortgages are purchased.
Attorneys are weighing in the legal aspects of the concept. New York Attorney General Eric Schneiderman has warned, “I think [it] should be a vehicle of necessity, and it’s controversial whenever you use it... You have to be careful about balancing all the interests.” He has one problem with the plan to acquire properties to save properties from foreclosure - it runs afoul of the law. On the other hand, Alexander Shalom, Senior Staff Attorney ACLU of New Jersey, stated,
“There are legal concerns and we want to be measured to make sure that we are not overlooking any of them but don’t want banks to scare cities away from fully considering these options. So there are legal concerns but those are in the details not in the big picture about whether eminent domain can be sued to seize a mortgage.” The ACLU of New Jersey and the Brooklyn-based Center for Popular Democracy filed suit on January 5, 2014 against the FHFA demanding that it disclose details about its relationship with banks and other financial institutions.
The debate and ensuing litigation may continue indefinitely. As legal research continues, municipalities will undoubtedly be advised of the possible unconstitutionality of the use of eminent domain to seize underwater mortgages given the public purpose mandate. Even under Kelo v. City of New London, in which the U.S. Supreme Court found that it was appropriate to use the power of eminent domain for economic development, the proposal to seize underwater mortgages may violate the requirement that a taking be for a public purpose because only certain homeowners will benefit.
Assuming that the government has the authority to take a mortgage for a public purpose under the power of eminent domain, the proposal as it stands is still not practical. In New Jersey, if property is acquired by eminent domain, the owner must receive just compensation at the fair market value of the property. Fair market value has been defined as the amount that a willing buyer and seller would pay for the property in an arms-length transaction. The fair market value of the underwater mortgages to be taken will be the present value of the amount that remains due on the mortgage. Municipalities will then be responsible for compensating lenders for a value greater than that of the home securing the mortgage. The resulting financial loss will undoubtedly be passed along to tax payers. This would be completely unacceptable for today’s cash-strapped municipalities.
If a municipality does decide to risk litigation with lenders by implementing a plan and seizing underwater mortgages, the matter will likely take years to reach the Supreme Court for resolution. In our opinion, this type of litigation will cause unnecessary exposure to the municipalities, because the takings would not meet the threshold of public purpose justifying condemnation.