The Constitutionality of Using Eminent Domain to Condemn Underwater Mortgage Loans

One of the most visible and devastating components of the financial crisis that began in 2007 and 2008 has been a nationwide foreclosure crisis. In the wake of ultimately ineffective attempts at federal policy intervention to address the foreclosure crisis, a private firm has proposed that counties and municipalities use their power of eminent domain to seize "underwater" mortgage loans-mortgage loans in which the debt exceeds the value of the underlying property- from the private securitization trusts that currently hold them. Having condemned the mortgage loans, the counties and municipalities would reduce the debt to a level below the value of the property and then sell the new loans to private investors. This Note contends that while the condemnation of "underwater" mortgage loans is likely constitutional under the Takings Clause of the Fifth Amendment to the U.S. Constitution, it would likely not survive an Article I Contracts Clause challenge, despite the moribund nature of Contracts Clause jurisprudence over the last half-century.INTRODUCTIONThe 2007-2008 financial crisis caused foreclosures to skyrocket from a precrisis average of 252,000 per year1 to more than 900,000 in 2009.2 The federal government's attempts to solve this wave of foreclosures failed to provide meaningful relief to either individual homeowners or the struggling housing market.3 As a result, the number of foreclosures rose even higher- to more than one million in 20104-before falling slightly to more than 860,000 between March 2011 and March 2012.5 As of January 2012, another 1.4 million homes were in the process of foreclosure, moving through the pipeline to join the 3.3 million homes that have gone into foreclosure since the crisis began.6Federal policy failures, however, do not limit the creativity of local governments. 7 In 2011, the private investment firm Mortgage Resolution Partners approached San Bernardino County, one of the counties hit hardest by the foreclosure crisis, proposing an unusual solution that the county could implement without the federal government.8 Its proposal targeted "underwater" home loans, loans in which the outstanding balance is greater than the value of the real estate that secured the debt. Local governments would use eminent domain to seize these loans from the financial institutions that hold them. They would then cut the debt to 95 percent of the value of the real estate and sell the loans to select private investors. The firm claimed that this plan would be everything federal efforts were not: flexible, cheap, aimed at underwater homeowners, indifferent to moral hazard, and not premised on loan holders' voluntary compliance.9A number of localities have publicly considered adopting this plan to condemn underwater loans ("the Plan"), or some variation of it, since the firm first pitched it to counties and municipalities in California's Inland Empire. San Bernardino County was the first to consider adopting the Plan,10 although it later decided against doing so;11 Chicago and Sacramento, among others, have also taken steps toward implementing the Plan.12 Recently, Richmond, California became the first city to begin implementing the Plan, and a coalition of investors has already filed suit against the city.13This Note argues that seizing underwater mortgage loans, although a constitutional exercise of the power of eminent domain, is unconstitutional under the Contracts Clause. Part I describes the conditions that have led local governments to consider the Plan and outlines how the Plan would function. Part II argues that the Plan would likely be constitutional under the Takings Clause because it is a rational response to the problems of blight and market malfunction. Part III, however, considers the Contracts Clause bar to the implementation of the Plan and concludes that the Plan may resurrect this clause from its jurisprudential grave by presenting the first serious Contracts Clause concerns in decades. …