If you follow news about eminent domain on line, and of late in the press, you surely must know about the proposal of some San Francisco investors to use the power of eminent domain to take “underwater” mortgages at their actual fair market value, not their nominal value. They would then (a) write them down and make them available in lower amounts to the people who own the “underwater” homes that are security for those mortgages, and then (b) bundle them into new marketable securities (bonds) and sell those to investors at a profit. Most of the on-line chatter has dealt with the question whether this would be a constitutionally permissible “public use,” and not without reason. While you may think that given the Kelo holding, anything goes as far as the courts are concerned, that may not be necessarily so. On the subject of mortgages, the amount of other types of mortgages is rising, including a subprime mortgage, which enables those with a bad credit score to access loans.
The adverse reaction to Kelo has come not only from the people, but also from a number of state courts who evidently believe that SCOTUS has gone too far. Thus, the supreme courts of Michigan, Illinois, Ohio, South Carolina, and Oklahoma have taken the position that redevelopment-style takings intended to transfer private property from its rightful owners to other private parties, in the hope that the new owners will put them to a more profitable use and thereby improve the community’s economic condition, do not meet the criteria of constitutionally permitted “public use” under their respective state constitutions. In other words, these courts evidently think that rdevelopment should primarily redevelop communities, not make money for redevelopers.
Also, the huge negative reaction to Kelo (some 90% of respondents held a negative view of that SCOTUS decision) may give appellate judges second thoughts. After all, shortly after Kelo came down, Justice John Paul Stevens, the author of the majority opinion, noted in a speech to the Nevada Bar Association that on some SCOTUS decisions the court should take a “mulligan,” and a justice of the Connecticu Supreme Court has apologized to Susette Kelo in public. So, assuming a modicum of decency on the part of state appellate judges, there may be some second thoughts developing among them on how expansively the power of eminent domain should be interpreted in future cases.
Our crystal ball doesn’t work well enough to plumb this mystery, but it does not seem unreasonable to suppose that the justices may, just may, be thinking about a doctrinally and politically convenient way to curb the excesses of eminent domain law, without having to eat crow in public. And what better vehicle for doing that than saying “No” to a group of unsympathetic high flying financiers who want to harness the government’s power of eminent domain for their own financial gain?
The proposal for this newfangled application of the power of eminent domain is (at least at this time) aimed only at taking mortgages that are performing; i.e., mortgages on homes whose owners, though “underwater,” continue to make payments on their loans, so that everybody involved is content to continue the status quo. Which is another way of saying that what these guys are after is low-hanging fruit. So we will have to wait and see if they go ahead with this scheme, and if so, how it turns out. Remember that under existing constitutional law, it’s OK if the taking benefits private parties, provided such benefit is incidental to the public purpose. Here, that is not clear and it may be difficult to say whether the “incidental benefit” tail is wagging the “public use” dog.
But to us, the real problem is valuation. How do you value an “underwater” mortgage that is bundled with other mortgages which together form securirty for a bond? How will such a taking affect the value of the bond that will, after such a taking, be secured by fewer (and lower quality) mortgages than those in the original bundle? Sounds like the bondholders would be entitled to severance damages when the taking of part of their security diminishes the value of the remainder.
And of course, the market value of the performing mortgages that have been targeted by this scheme, may not be as depressed as some folks think. A home financed by such a mortgage may be “underwater,” but a performing mortgage still produces a steady cash flow, so that if capitalized, it may indicate a higher value than the house using it as security for the purchase loan.
So we will just have to stay tuned and see how it all turns out.