Stupid Scheme on Eminent Domain Meets Predictable Fate

Last week I wrote about an innovative but dubious plan put together by a venture-backed financial firm to have cities use their eminent domain power to seize mortgages at below the value of the collateral, sell them to owners at a slight markup and thereby solve the problem of underwater mortgages in their community by handing mortgage bond investors a big loss -- not to mention giving Mortgage Resolution Partners LLC, the firm who thought this up, a nice fee.

The idea had so many problems, legal and otherwise, that I didn’t even get to touch on all of them. For example: The Internal Revenue Service usually treats debt forgiveness as taxable income. What happens if this innovative financing plan triggers a tax bill of tens of thousands of dollars for the homeowner?

But all of that seems to be moot, because the regulators who oversee Fannie Mae and Freddie Mac are signaling, as I predicted they might, that they are not going to play ball. As the Los Angeles Times reports:

"The federal housing agency, which regulates Fannie and Freddie, on Thursday made clear it doesn't intend to let this happen. The agency said it would instruct Fannie and Freddie to 'limit, restrict or cease business activities' in any jurisdiction using eminent domain to seize mortgages."

And that, it seems, would be that. It’s not entirely clear whether Fannie and Freddie are saying they won’t refinance houses seized in this manner, or whether they’ll pull out of the cities that try this altogether, but it hardly matters. If it’s the latter, the local housing market will, for all intents and purposes, cease to exist, since the government now provides about 90 percent of the mortgage loans in this country. If it’s the former, the market for these houses ceases to exist, which means that the city would be taking an underwater asset worth less than its mortgage, and transforming it into an underwater asset worth almost nothing. Either way, it’s a stupid plan, and the local politicians would have to be insane to go forward with it, regardless of the outcome of the various lawsuits that have been filed to stop them.

I used to be enamored of these sort of elegant schemes to comply with the technical letter of the law while doing something that it purports to forbid -- like enacting a tax on ammunition to end-run constitutional limits on gun bans. But after more than a decade of policy reporting, I see them mostly as quixotic. Judges and regulators are not Rumplestiltskin -- they don't disappear as soon as you say the magic word. You can construct your elegant scheme, but if they think you’re doing something obviously outrageous, they’ll find an equally elegant way to shut you down.

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.