Taking Mortgages by Eminent Domain (Cont’d.)

As we noted a few days ago (click here), there is an idea afoot whereby mortgages of “underwater” homes would be taken by eminent domain at their fair market value, not the nominal loan balance (which is much higher), and then the loans secured by them would be restructured to make them affordable to the “underwater” homeowners who could now resume paying off their restructured, lower balance mortgage with payments they could afford. The losers would be the lenders who lent money on those mortgages but who now would receive the current fair market value of their secured note, which these days is a lot less than what they originally lent because those mortgages aren’t likely to be repaid so they are not worth nearly the amount of the loan. Sounds deceptively simple to us. Aside from the fact that, as we noted earlier, this could jeopardize the soundness of some banks holding these loans, it turns out that there are other complications — like the fact that a lot of those loans are guaranteed by the government or by Fannie and Freddie, and many of them have been securitized into mortgage-backed bonds.

Anyway, we just came across an article by Reuters.com that describes this poposal in more detail, and deals with some of these complications. It’s Felix Salmon, Why Using Eminent Domain for Liens Is a Bad Idea — click here. If you are interested in this subject, it’s a good read that explains some of the problems with this scheme and reminds us, if any such reminder were needed, that the devil is in the details. And one of these details is what to do in states in which mortgage loans provide for recourse against the borrower when the mortgage is foreclosed on but the foreclosure sale does not bring enough to cover the loan balance.

In the meantime the Internet is buzzing with news stories about this proposed scheme, although most of what is said is rather superficial. But San Bernardino County in California is apparently going ahead with this scheme, being as it got hit hard by the collapse of the “bubble.” So stay tuned and see how it turns out.

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