A New Direction for Eminent Domain: Rescuing Underwater Mortgages

By Cristina Riggio

Nearly six years have lapsed since national residential real estate prices peaked and subsequently dropped.[1] Today, real estate prices remain at thirty percent beneath the normally anticipated levels. Current statistics demonstrate an even bleaker image for “harder-hit” communities where prices persist at fifty percent below peak levels. Moreover, the market has yet to reveal a steady rise of prices. At best, “cyclical fluctuations” temporarily push prices up, only for them to steadily regress back.[2] For a mortgage to be underwater, the home’s fair market value must be less than its mortgage. In short, the home’s value lies in its mortgage. Of these outstanding mortgages, three to four million remain in default, in foreclosure, foreclosed, or are expecting liquidation.[3] Nearly two million mortgages default each month. Accordingly, 7.5 to 9.5 million additional homes are projected to be liquidated over the next several years.  Without remedial action taken, these numbers for liquidation would further instigate an already bleak and depressed market. The number of vacant homes would equate to 200 percent of the U.S. annual home sales.  The devastation is ubiquitous and far-reaching. Homeowners are forced to give up their homes. Neighbors of vacant lots lose property value while being subjected to blight. Thus, the economic welfare of the affected communities will be further devastated. [4]

 

A solution is needed to divert mortgage loan default, delinquency, and foreclosure. Economists and creditors concede that the most effective solution to underwater mortgages would be to provide struggling homeowners with financial relief through a reduction in their principal. While economists almost unanimously agreed on the actual solution, principal write-downs, the process to carry out the write-downs proved to be a challenge.  Private-label securitization (PLS) trusts bear structural characteristics that make principal reductions uncommon. Since such a collective and needed action is unlikely, creative economists developed a different approach to maneuver around this hurdle: state and municipal governments shall exercise their eminent domain powers to confront these collective action hurdles.

The Constitution’s Fifth Amendment states, “No person shall be . . . deprived of life, liberty, or property, without due process of law; nor shall private property be taken for a public use, without just compensation.”[5] The Due Process Clause maintains that for Congress to pass a law, the law must substantially advance a legitimate public purpose. The Takings Clause maintains that if private land is taken for a public use, the aggrieved property owner must be justly compensated with the property’s fair market value.[6] The eminent domain power encompasses all types of property, both tangible and intangible. These varying forms  of property include contract rights[7], insurance policies[8], sport franchises[9], and hunting rights.[10] Moreover, the Supreme Court and state courts have recognized the use of eminent domain over mortgage loans and liens.[11] Accordingly, it remains undisputed that the power of eminent domain extends to underwater mortgages.

The issue remains, however, whether exercising eminent domain to take over negative equity (underwater) mortgages would advance a legitimate public interest. The Supreme Court considered a similar issue in Kelo v. City of New London.[12] The city of New London had approved a redevelopment plan that was anticipated to create over one thousand jobs, increase tax and other revenues, and revitalize the economically depressed city. To carry out this plan, the city’s development agent purchased property from willing sellers.  However, not all residents were as forthcoming, subjecting the city developer to turn to Connecticut’s eminent domain power. Petitioners questioned whether New London’s use of their property qualified as a public use as defined in the Takings Clause of the Fifth Amendment.

Since Kelo was not a case in which the city planned  “to open the condemned land- at least not in its entirety- to use by the general public”, the Court determined whether the land’s use served enough of a public purpose within the meaning of the Fifth Amendment’s Taking Clause.[13] In a 5-4 decision, the Supreme Court concluded that the taking should be upheld as consistent with the Fifth Amendment’s Taking Clause since New London’s economic revitalization project is “rationally related to a conceivable public purpose.”[14]  As nationwide cities begin using eminent domain to revitalize their real estate markets, it will be interesting to see how courts reconcile these already existing concerns with the problems at hand.

 


[1] Robert Hockett, “Paying Paul and Robbing No One: an eminent Domain Solution for Underwater Mortgage Debt”, 19 Current in Economics 5, 1 (2013).

 

[2] Id. at 1.

[3] Id. at 2-3.

[4] Id.

[5] U.S. Const.  amend. V.

[6] John R. Nolon & Patricia E. Salkin, Land Use in a Nutshell 130 (Thompson West ed., 2006.

[7] See, e.g., U.S. Trust Co. of N.Y. v. New Jersey, 431 U.S. 1, 21-26 (1977).

[8] See, e.g., Lynch v. United States, 292 U.S. 571, 577-79 (1934).

[9] See, e.g., City of Oakland v. Oakland Raiders, 646 P.2d 835 (Cal. 1982).

[10] See, e.g., Kimball Laundry Co. v. United States, 338 U.S. 1 (1949).

[11] See, e.g., Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555, 602 (1935)( “If the public interest requires, and permits, the taking of property of individual mortgagees in order to relieve the necessities of individual mortgagors, resort must be had to proceedings by eminent domain; so that, through taxation, the burden of the relief afforded in the public interest may be borne by the public.”).

[12] Kelo v. City of New London, 545 U.S. 469 (2005).

[13] Id. at 479.

[14] Id. at 491.

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