Eminent Domain and Underwater Homes

The recent discussion about proposals in San Bernandino and other cities to use eminent domain to, in effect, force a principal reduction in mortgages that are underwater is quite interesting. Setting aside the question of whether this is a good idea, I’m wondering if there is a valid constitutional objection here.

It seems clear that Congress could order a principal reduction in mortgages under its Commerce Clause powers.  State legislatures could probably do the same, though I’d have to look at the fine print in Blaisdell to confirm that assumption.  (What, at this point, does the Contracts Clause do?)  I’m not an expert on takings law, but it does seem strange to say that if the state takes my house and pays me the fair market value, then gives the house to a third-party to sell back to me at a lower price, that the bank must give me, the homeowner, a mortgage for that now-cheaper house?  Why is that exactly?  And won’t I still take a big loss?

Now I guess the state could set “just compensation” at higher than market level (in effect, a bailout) of the homeowner that would allow the bank to recoup its principal, then put the house back on the market (at market value) with an option to the homeowner to, if he or she could get a mortgage, buy back the house.  (Nobody, I guess, has standing to challenge an overly generous payout for eminent domain.) Is this what people have have in mind?  If so, it seems unlikely to work.  Distressed municipalities won’t have the money, and states will lack the political will to help some homeowners at the expense of others.

What I am missing here?

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7 Responses

  1. Dan Cole says:

    My sense is that the Contract Clause might play a bigger role than you suggest. In this scenario, the purpose of the exercise of the Commerce Clause would be for the specific purpose of renegotiating existing private contractual arrangements (unless you could claim, pursuant to some formalistic legal theory, that a mortgage agreement is not a contract but a property transaction).

    And once the government takes the property by eminent domain, how could it then reallocate the property in a way that would ensure that the original owner remained in possession and could obtain a more manageable mortgage?

    Dan

  2. Jennifer Hendricks says:

    I don’t think this is the San Bernardino plan, but the idea I had heard was to exercise eminent domain against the _loan_. The city says to the bank, “We know you’re holding a note that says it’s for $100,000, but given the likelihood of default the market value of it is only $50,000, so that’s what we’ll pay you for it.” Then the city (or an investor to whom the city re-sells the note) works out the new deal with the homeowner to repay, say, $55,000.

  3. Gerard Magliocca says:

    OK, that makes more sense. Would such a plan be preempted by any federal statutes regulating the housing market?

  4. Jennifer Hendricks says:

    No idea, but I just googled it, and it seems it is the S.B. plan. From HuffPo: “The idea was broached by a group of West Coast financiers who suggest using the power of eminent domain, which lets the government seize private property for public purpose.” I heard last year that these “financiers” had had the idea vetted by one or more law profs.

  5. Ken Arromdee says:

    We know you’re holding a note that says it’s for $100,000, but given the likelihood of default the market value of it is only $50,000, so that’s what we’ll pay you for it.

    I don’t quite see how that works.

    It would be quite an incredible coincidence for “fair market value of the mortgage, considering default” to equal the value of the house. There’s no reason for those two numbers to match; it’s just as plausible that the house is worth $50000, the mortgage is $100000 on paper, and the risk of default only reduces the value of the mortgage to $80000.

    It sounds like this only works because it’s easy for the government to lie about the fair market value when exercising eminent domain.

  6. TS says:

    Why would this not be preempted by federal bankruptcy laws (under either conflict or obstacle=types preemption) that seek to rearrange relationships between creditors and debtors?

  7. Josh says:

    “Nobody, I guess, has standing to challenge an overly generous payout for eminent domain.”

    Taxpayers would, in the vast majority of states. For a more extensive discussion, see my upcoming article in the Fordham Law Review this December. Also see the Hershkoff and Briffault pieces that I extensively cite and discuss.