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Eminent Domain for Underwater Mortgages… Another Bad “Bail Out” Idea?

California found it’s self in the middle of a national debate last year when San Bernardino County, considered the Eminent Domain tactic as a way of helping residents victimized by the recent housing crisis.

With push back from Wall Street groups and the lack of public support the idea never materialized. Well, the rob from Peter to pay Paul method of homeowner bailout is once again being considered.

The meager Bay Area city of Richmond, California announced that it had proposed to the holders of over 600 underwater mortgages, homes where the borrower owes more than the property is worth, to sell the loans to the city of Richmond at a discount. Then the city would refinance the loans for amounts more in line with current home values.

If the lenders refused to play along, the city would just use eminent domain powers to force the dealings… sit back and watch the lawsuits roll in.

If you are not familiar with the whole eminent domain thing, here it is in a nut shell… “The power of the state to take private property for the use in a public project in return for reasonable compensation. Reasonable compensation is defined in terms of fair market value of the property.”

I’m pretty sure that bailing out underwater homeowners is not the intended purpose of eminent domain. And while people like to place the blame for the housing crisis on the lenders (which is an uneducated view) it is not right for the holders of some 600 plus mortgages to have them taken away. I doubt that the sales of these loans will be voluntary, like the cities says. Likely they will be loan sales under pressure.

The whole plan seems a little shady to me, here what they have in mind… Working with a private investment firm, the city would write-down the loan balance if they could purchase the debt at a discount to the current market value of the home. Then, they would get their cash back and cover the costs of the transaction by refinancing the smaller loan into a mortgage backed by the Federal Housing Administration.

Well, Richmond is looking to purchase loans with balances as high as $1.12 million, the problem with that is the FHA only guarantees mortgages with balances as large as $729,750 in high-cost markets such as San Francisco.

This whole deal has such a bad smell that even the fine upstanding executive at Freddie Mac said they would consider legal actions to block this from happening if Richmond moves forward with their plan.

The city plans to pool the purchased loans together and sell them to investors as mortgage-backed securities. These so-called “private-label” securities would be issued by Wall Street firms, not by Fannie Mae or Freddie Mac and if the FHA passes on the deal, would lack any government backing. …Wasn’t it crappy mortgage backed securities that started that little housing crisis we had a few years ago? I don’t see how any smart investor would touch this deal.

While I empathize with homeowners that are underwater, I’m in that sinking boat also, I think the government, be it local or national, needs to stay out of this mess and let the market fix it self. It was government meddling (along with irresponsible home buyers) that got us into this mess in the first place.

I guess this is one of those “let’s wait and see what happens” moments.

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