When Eminent Domain Squeezes Property Rights

Desperation is driving some politicians to go where no government has gone before. The City Council of Richmond, Calif., voted in September to use the power of eminent domain to condemn 624 mortgages in which the homeowners owed more than the current market value of the property. The vote threatens to bring mortgage financing for residents to a crashing halt. If successful, the move will expand the power of eminent domain well beyond any previous boundary by applying it not to the home, but the mortgage, which is entirely separate. It would cause tremendous damage to the residents of the city in both the short term and in the long term.

U.S. District Judge Charles Breyer threw out a lawsuit filed by the various bondholders to block the city’s move on the grounds that it was too early to sue — the city had not yet voted to ask the state courts to seize the mortgages. That merely defers the potential for ruinous litigation for the city and its taxpayers and leaves the courthouse door open for bondholders to return if the city chooses to proceed.

Property values plunged in Richmond, as they did in many cities across the country, when the housing bubble burst and left many homeowners “underwater” on the mortgages — owing more than the value of their loans. Nonetheless, most of the 600-plus mortgages under question are current, with the homeowners continuing to make their payments. Arguably, these mortgages are at little risk of default. Furthermore, there is little risk of blighted neighborhoods, with many of the homes being in excess of 3,000 square feet, relatively large by California standards. At least one is valued at more than $1 million. Moreover, home values in Richmond have been rising recently, and these homes, even if foreclosed, are likely to sell fairly quickly. There is little justification for the action on the grounds of preventing blight, which is all too often used as a basis for condemnation of property.

In this case, it’s not the property that’s being condemned, but the debt instrument associated with it. The city of Richmond’s actions, therefore, expand the scope of eminent domain in a different fashion than that resulting from the Supreme Court’s 2005 ruling in Kelo v. City of New London, Conn. In that case, the high court allowed a Connecticut city to condemn a well-kept home to make way for an office park, using a looser definition of “public use” within the framework of the Constitution. The Fifth Amendment says “no private property [shall] be taken for public use, without just compensation.” Nonetheless, governments have increasingly stepped in to take property from owners unwilling to sell for uses far from the traditional ones of public highways or parks. Now, eminent domain is being employed to pave the way for uses as diverse as sports stadiums and shopping malls.

This is an entirely novel approach, and its constitutionality is, at minimum, open to question. The economic impact is far clearer and far worse for the residents of Richmond.

One of the attractive features of mortgages is that they can be securitized, or resold. The California State Employees’ Pension Fund holds many of the mortgages at issue in Richmond. If mortgages can be subject to condemnation under eminent domain, and their value arbitrarily rewritten, no private buyer is likely to be interested. The Federal Housing Authority has indicated that it might order Fannie Mae and Freddie Mac to stop lending in areas where the government has chosen to use eminent domain to restructure mortgages. This would effectively choke off mortgage financing, since the Federal Housing Authority, Fannie and Freddie cover about 90 percent of new mortgages.

When buyers cannot get financing, they are not in a position to buy a home. That leaves sellers with fewer options. So, while the eminent domain proceedings in Richmond might directly affect the 624 homes, they could strangle home sales in the entire city. This would drive down home prices, making the problem of underwater mortgages worse for the city as a whole. If the city continues to pursue this option, it could also land back in court, and taxpayers, many of whom are unable to afford a home of their own, will have to foot the bill for the litigation.

The eminent-domain proceedings could help the few people who have their mortgage reduced, but there would be few other winners and a great many losers. It is past time for eminent domain to return to its original purpose, with condemnation reserved for true public use, and just compensation paid.