Thursday, November 21, 2013

A Tale of Two (or more) Cities: Can the Government Use Eminent Domain to Save Homeowners from Drowning In Loan Debt?

This is a loaded and, to date, not a fully answered question.  However, the idea has support from a Cornell University Law Professor and at least two cities within the last year, Irvington, New Jersey and Richmond, California, have considered implementing such a plan.

Irvington, New Jersey and Richmond, California could not be much further apart geographically, but both have suffered the same economic woes that would find this type of plan attractive.  Irvington falls within the New York City metropolitan area.  At one point, Irvington was ranked 17th nationally in population density. Several have moved out of Irvington with the population falling from 60,000 in 2000 to 53,000 in 2010. Irvington's biggest problems are high unemployment, crime, and blight.  Since 2008 nearly 1800 homes have been foreclosed.  

Richmond, California is located near San Francisco.  Its economy is made up of heavy industry and shipping and while Richmond has actually seen its population increase in the last decade, it has also experienced severely very high unemployment (between 18.5% in 2010 and 12.5% today).

The housing markets in both cities have also taken a beating, seeing home values rise and then sharply decline.  In Richmond, the average dollar per square foot reached a peak of $380 in 2005, but quickly after the housing crisis, it dropped to a low of $114 in 2009. In Irvington, the data is similar.  The average dollar per square foot reached $201 in mid to late 2007, but had declined to $43 as of early 2012.  The housing market reaction to each cities' negative factors was certainly appropriate, however, it punished those who were tied to high fixed mortgage obligations.  While home values traditionally rise in the long-run, they will fall during a recession, or in the cases of Irvington and Richmond, a seemingly endless depression.  

It is a simple formula, really: when people lose jobs, the family loses income.  When families lose income, they will be unable to pay bills and some bills, such as the mortgage, go unpaid.  And when mortgages go unpaid, banks get nervous and initiate foreclosure to secure the investment.  When there are no jobs in the community, no family income, and houses in foreclosure, the collective property values of a city will drop, resulting in a populous that is drowning in existing underwater mortgage debt.   Irvington and Richmond are probably just two highly publicized examples.  

Enter Robert Hockett, a Cornell University Law Professor with a novel solution.  Mr. Hockett's approach suggests that government apply their eminent domain power to acquire the underwater mortgage loans, and write-down the principal.  Why the government?  Because the local government has the desire to improve its locale, and may have the means of implementing a plan.  P
rivate banks are reluctant to write-down home loan obligations for a good reason.  Their existing contracts with the homeowners were based on a fixed rate.  The property values were determined at the time the parties entered into a contract, with the mutual understanding that times may change.  Furthermore, the home is also the bank's investment.  There is simply no incentive for a bank to write down the value of its own loan to bail out the homeowner.

However, a city could use its power of eminent domain to rescue those who are underwater in home loan debt.  Cities who implement the plan would purchase, and then restructure home loans by writing down the principle, and then issue new loans to the home owners that contemplate the home's depressed value.  The homeowner has a new loan obligation that contemplates the market value, and avoids foreclosure.

For those not a fan of government intervention, the idea of a city stepping in to purchase high-risk loans from taxpayers may seem alarming.  After all, the first question should be: who will fund the project?  Taxpayers are one source of revenue that a city could tap into, but one can not possibly imagine asking for a sales tax increase to fund the purchase of mortgages, and a city, already suffering, could not raise enough to resolve the problem.  The other and more likely source is through public or private loans or bonds.  According to Hockett, those who invest will be repaid from the proceeds of the refinanced and presumably more valuable loans.   

Legally speaking, there will be other hurdles.  Foremost is whether a city has the constitutional power to exercise the right of eminent domain in this regard.  Eminent domain is the power that is frequently used by cities to acquire a private property right, such as an easement, for a public purpose.  Cities using eminent domain must also pay the property owner just compensation for the acquisition.   

Proponents will argue that the prevention of foreclosures, increased tax revenue, and the overall improved city economic is a sufficient public purpose.  However, opponents will counter that a city-refinanced home only really assists the drowning homeowner.  After all, the city refinanced home will not become a public facility for all to use.  Furthermore, how does one qualify for such a project, and can the city implement a policy that will apply the project fairly to all citizens?  Further, what is "just compensation" for such an acquisition?  

Whether or not the use of eminent domain is appropriate will certainly become a hotly divided issue.  Two challenges to the procedure were recently dismissed by a California Federal District Court.  In both, Wells Fargo Bank v. City of Richmond, 13-03663, and Bank of New York Mellon v. City of Richmond, 13-03664, the court never reached the constitutional concerns, but rather, dismissed the cases because the legal issues were not yet ripe.  So, for now, cities like Irvington and Richmond appear free to proceed, but will be subject to looming constitutional scrutiny.  

I'm curious about what readers think about this proposal.  On the one hand, it is an opportunity for a suffering city to stop the bleeding.  But, at what cost?  

C. Michael Daily is an attorney with the long-established law firm of Daily & Woods, P.L.L.C.  Mr. Daily can be contacted by telephone at 479-242-3953, by email at mdaily@dailywoods.com, or by regular post at 58 South 6th Street, Fort Smith, Arkansas 72902.  You can follow Mr. Daily via social network using any of the social network links in the right hand column of the page.  Disclaimer:  This blog is for informational purposesis certainly not to be considered legal advice and is absolutely not substitute for any of the benefits that are associated with the attorney-client relationship.