Here's a new idea proposed to Congress yesterday by the National Community Reinvestment Coalition (NCRC): have the U.S. Government essentially condemn bad mortgages and take them using their power of eminent domain (paying a severely discounted market rate to their owners). Then the government could modify the mortgages however they wanted - most likely reducing principal amounts down to fair market value and allowing homeowners to stay in their home with a less burdensome loan.
This proposal is part of NCRC's "Help Now" solution to the foreclosure crisis. Under the original Help Now proposal (pdf), the government would simply buy these bad loans at a big discount from banks and holders of mortgage backed securities. Then they would modify the loans - writing down principal and solving a lot of problems. This plan would get around the current problem of investors in mortgage backed securities withholding consent to loan modifications, since the government would now own the loans.
But to get this done, of course, the banks and MBS investors would have to be willing to sell their mortgage portfolios at a steep discount and recognize losses. I'm guessing that wouldn't be a popular option for investors in MBS or banks with loan portfolios - who figure that the government should buy the mortgages at higher prices and the government/taxpayer should shoulder potential losses when writing down principal. (A variation of this asset pricing problem was the fatal flaw in the original TARP plan to buy bad assets.)
So enter the eminent domain idea from NCRC - a stick used to threaten banks and holders of MBS to sell at a low price or the government would just use eminent domain and determine what the fair market price of the portfolio of loans actually is (obviously they would say it's very low). No doubt this would lead to lots of lawsuits over the fair market value, etc.
The other challenge made of course would be whether the taking was for public use as required by the U.S. Constitution. (Note that the taking addressed is of "private property" and isn't limited to real estate.) This is usually the crux of eminent domain disputes and a source of a long line of property law precedent in the courts. The most recent U.S. Supreme Court decision was in 2005, which endorsed a fairly expansive interpretation of "public use" as set forth in the U.S. Constitution. They said that use of eminent domain is permissible even if the taking of property was used for private economic development by private developers - as long as there was a public benefit (in this case urban revitalization). So the question would turn on whether the U.S. Government taking these mortgages (private property) using eminent domain would be for the public use or benefit. An argument could be made for that fairly easily I would argue, but it certainly isn't a clear cut case.
I won't get deeper into the history of eminent domain, but it is a fairly controversial power used by governments and often disputed in court. Which leads me to believe that while the plan may theoretically work, it would probably get bogged down in the court systems long enough for it not to be effective in time to help stem the foreclosure tide. But I guess it would keep the bankruptcy judges out of the process...
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