FHFA's Stand Against Eminent Domain Plans Likely to Prevail

WASHINGTON — The Federal Housing Finance Agency threatened Wednesday that it would take action against municipalities that attempt to use eminent domain to refinance underwater mortgages.

While it stopped short of specifying what moves it would make, experts said the federal agency is likely to prevail, noting it has jurisdiction to stop local governments like San Bernardino County and the cities of Fontana and Ontario in California from seizing mortgages.

"San Bernardino County cannot condemn federal property," said Gideon Kanner, professor of law emeritus at Loyola Law School in Los Angeles and a longtime eminent domain expert. The FHFA is "a federal agency and the Feds can take the property of a state or city but the state or a local entity cannot take federal property."

Robert Thomas, an attorney at the law firm Damon Key in Hawaii, called FHFA's response "a pretty strong shot across the bow," warning municipalities to rethink the idea of seizing mortgages.

"Federal property is immune from state and local condemnation so FHFA is trying to nip this before it gets to the courthouse door," Thomas said. "This idea to seize performing but underwater mortgages has always been more smoke because the proposal is based on a couple of assumptions that may not be true."

Anthony Della Pelle, an attorney at McKirdy Riskin in Morristown, N.J. agreed that municipalities may have trouble seizing loans owned by a federal agency.

Loans owned by a private bank or other lending institution would have to satisfy the two primary requirements for eminent domain seizures of having a public purpose and providing just compensation to the owner of the mortgage, he said.

But in a notice issued Wednesday, FHFA said seizing loans from bondholders may increase taxpayer losses on the government-sponsored enterprises and ultimately spur a credit crunch in the mortgage market.

"FHFA has significant concerns about the use of eminent domain to revise existing financial contracts and the alteration of the value of enterprise or bank securities holding," the agency wrote in a notice.

The agency warned that "resulting losses from such a program would represent a cost ultimately borne by taxpayers" and that it could "have a chilling effect on the extension of credit to borrowers seeking to become homeowners and on investors that support the housing market."

FHFA's notice followed a decision last week by the city councils in Berkeley, Calif., to consider using eminent domain to refinance borrowers. Chicago's City Council adopted a similar resolution last month. In June, San Bernardino County and the two California cities created a Joint Powers Authority to explore whether to use eminent domain to buy mortgage loans, sparking an uproar among bondholders.

David Wert, a spokesman for San Bernardino County, said officials are interested in FHFA's input.

"If the FHFA has legitimate concerns it should share those concerns with the county," Wert says. "The more input we can get from agencies such as FHFA and anyone else will help us make an educated decision. The county and its partners have not decided which approach to take in assisting struggling homeowners."

San Bernardino officials are expected to hold a public meeting on Aug. 16 and issue a request for comment on the plan that would use private funds raised by a San Francisco venture capital firm, Mortgage Resolution Partners, to acquire and restructure "underwater" mortgages. Bondholders have objected to the plan, in part, because the homeowners are not in default and are still paying their mortgage even though they owe more on their loans than their homes are worth.

Some analysts say eminent domain are unlikely to proceed in light of FHFA's opposition.

"We remain pessimistic about the ultimate potential of this plan succeeding in a scalable manner," Isaac Boltansky, a policy analyst at Compass Point Research & Trading, wrote in a note to clients. "The tone the FHFA has taken in this notice only reinforces our view that the eminent domain proposal will not come to fruition."

But not everyone agreed, with some analyst predicting that municipalities will move forward.

"Our view continues to be that at least one community will use eminent domain to refinance underwater borrowers," wrote Jaret Seiberg, a senior policy analyst at Guggenheim Partners, in a note to clients. "If that community is perceived to have helped voters, then we believe eminent domain use will spread to hard hit housing communities throughout the country despite FHFA's warnings."

FHFA oversees entities that hold more than 15% of the $1.3 trillion of private-label mortgage-backed securities. Fannie and Freddie held $206.5 billion of private-label mortgage-backed securities at the end of May, according to the government sponsored enterprises' monthly summary reports. The 12 Federal Home Loan Banks held $17 billion of such securities, according to their first quarter combined financial report. The figures represent the unpaid principal balances of non-agency holdings.

FHFA has set a deadline of Sept. 7 for the public to comment on the issue.