What are they thinking? Several cities throughout the country have either implemented orare toying with utilizing eminent domain to force lenders to sell underwater loans at steep discounts. The idea is that the municipality would buy the loans at a large discount, write off some of the principal and then refinance the loans. As an article in the August 6, 2013 Los Angeles Times reflects, the California cities of El Monte, Ontario and Fontana are considering such a move. The City of Richmond has actually started the process.
As anyone with knowledge of the lending industry would know, this is an extremely bad and even dangerous idea. Besides forcing lenders to take large losses while assuming that the homeowners have no responsibility for purchasing homes that they could not afford, there is also an immense ripple effect that will negatively impact these communities-lenders will stop lending in these communities. If lenders are faced with the prospect that if the value of their security (the home) goes down that the City will force them to sell the loan at steep discount, lenders will simply take their money and loan it elsewhere.
This position has been echoed by the Federal Housing Finance Agency (FHFA) which regulates Fannie Mae and Freddie Mac. The FHFA has announced that it would instruct Fannie Mae and Freddie Mac to “limit, restrict or cease business activities” in any jurisdiction using eminent domain to seize mortgages.
Recently, Fannie Mae, Freddie Mac and bond holders sued the City of Richmond seeking an injunction against the use of eminent domain to force lenders to sell their loans. Hopefully, this effort will be successful and put a stop to cities taking measures that will result in drying up the sources of lending for their communities.