Eminent Domain Debate for Mortgages Revived by Fed Paper

A report by a visiting professor at the New York Federal Reserve is reviving the debate over using government powers of eminent domain to seize mortgages of underwater homeowners to ease their debt.

Eminent domain, which traditionally has been used by local governments to seize blighted property or other land for public good, may reduce foreclosures by helping borrowers who owe more than their homes are worth, Robert Hockett, a professor of financial law at Cornell University, said in the report, published June 9. The study may spur municipalities to reconsider the proposal after it was dropped last year, said Jaret Seiberg, an analyst at Guggenheim Securities LLC.

“Housing industry efforts to date have kept the eminent domain advocates in check,” Seiberg wrote today in a note to clients. “Our worry is that the latest paper from the Federal Reserve Bank of New York will change that equation even though the paper only reflects the views of the author and not of the New York Fed.”

Using eminent domain to confiscate and write down mortgages was first proposed last year in California’s San Bernardino County and has been explored in Chicago and New York’s Suffolk County. It’s been opposed by Pacific Investment Management Co., AllianceBernstein LP and the Securities Industry and Financial Markets Association, who have argued it would make lending more costly in hard-hit areas by raising the risks of investor losses.

‘Serious Traction’

“This paper will likely cause the discussion surrounding the use of eminent domain to re-emerge, but we continue to doubt that any such effort will gain serious traction,” Isaac Boltansky, an analyst with Compass Point Research & Trading LLC in Washington, wrote in a note today.

Hockett, a visiting scholar at the New York Fed, has advocated for eminent domain refinancings since 2008, according to Seiberg.

Writedowns by banks of privately securitized mortgages “are almost impossible to carry out, since loan modifications on the scale necessitated by the housing market crash would require collective action by a multitude of geographically dispersed security holders,” Hockett wrote in the paper, called “Paying Paul and Robbing No One: An Eminent Domain Solution for Underwater Mortgage Debt.”

About 13 million U.S. homeowners are underwater, according to a report last month by Zillow Inc. That number is expected to fall 1.5 million by next year as home prices rise at their fastest pace since 2006, the Seattle-based online real estate information service said. Las Vegas, Atlanta and Orlando, Florida, had the highest rate of underwater mortgages among the 30 largest cities tracked by Zillow.