Ever since the Supreme Court issued its astoundingly bad decision in
Kelo v. City of New London, local governments have been encouraged to use eminent domain schemes to grab private property for the commercial benefit of their well-connected cronies -- all in the name of public welfare. The schemes are getting more sophisticated now. An enterprising company called Mortgage Resolution LLC has put together a package that's
tempting a number of municipalities, especially in the law-free zone known as California, though nibbles of interest are coming in from Seattle and Newark as well. The gambit is to identify home mortgages that are underwater but current on their payments. Mortgage Resolution LLC puts together a local package of these mortgages whose borrowers pass a credit test, then persuades the local government to "condemn" the mortgages at a price equal to 80% of the home's fair market value. The lenders (typically owners of mortgage-backed securities pools) take a hit equal to the excess of the mortgage balance over the home's value, plus 20% of the home's value. Mortgage Resolution LLC then refinances the homes through the FHA and pays the local government a percentage of its profits. It's like a tax on highway robbery: the more we rob, the more the city collects in taxes! And the people we rob mostly live out of state, anyway, so who cares?
Boston law firm Ropes & Gray has filed a
lawsuit challenging the scheme on constitutional grounds. At issue is the horrendously confused law of eminent domain and "public use" in the wake of the
Kelo decision. That case left open the possibility of relief for eminent domain schemes in which the seizure of property was a mere "pretext" rather than a good-faith pursuit of the public welfare. Later courts, however, have struggled to develop a workable definition of "pretext."
The
Kelo decision spurred action in many state legislatures to curb the power of local government to grab any property they thought might be convenient for the visionary real estate development schemes of their cronies. These legal fixes evidently hadn't much teeth in California, Washington, or New Jersey. In any event, the idea of grabbing and reselling mortgages rather than homes is a fresh and exciting abuse that offers up the possibility of ensuring that the loss lands on faceless profit-grubbing lenders instead of photogenic local homeowners. It still amounts to theft, however, and in the long run it won't help homeowners ensure access to a reasonable mortgage market.