The Price of Crisis: Eminent Domain, Local Governments, and the Value of Underwater Mortgages

Governments at all levels in the U.S. have deployed a range of tactics to address some of the most pernicious effects of the Financial Crisis of 2008: namely, a loss of trillions in homeowner equity as well as the growth of the prevalence of underwater mortgages, where the outstanding principals on the mortgages exceed the value of the underlying properties. Among other tactics for addressing such impacts, local governments have begun to explore whether it is wise and legal to use the power of eminent domain to seize distressed home mortgages. This Article attempts to situate this approach to such mortgages within the larger economic, legal and policy context to determine whether this approach has a sound basis in law and policy. To do this, we deploy the tools of Comparative Institutional Analysis to assess the potential viability of using eminent domain to seize underwater mortgages. In doing so, we review the wide-ranging efforts of governments at all levels in the United States to deal with the economic effects of the Financial Crisis of 2008. We look at the relative success of these different tactics used by these governmental entities — from ex ante regulatory approaches to ex post law enforcement and civil litigation strategies — to assess the most effective tools available to remedy the economic and social problems posed by distressed mortgages. We then determine whether the use of eminent domain by localities is consistent with those governmental responses to the fallout of the Financial Crisis that have proven effective in responding to some of its worst impacts: here, the loss of homeowners’ equity in their homes and the prevalence of underwater mortgages.In carrying out this analysis we ask, and attempt to answer, five key questions. First, are local governments appropriate actors to address the lingering problem of underwater mortgages? Second, what has been the relative success of the range of tactics that governments at all levels have used to address underwater mortgages, including law enforcement strategies and legislative and regulatory measures? Third, assuming local governments are appropriate actors to address this problem, how should localities and, if necessary, courts, value underwater mortgages in the context of condemnation proceedings: i.e., what is the appropriate amount of compensation that localities should pay mortgagees and other lienholders when seizing underwater mortgages? Fourth, what are some strategies local governments can use to find the resources necessary to finance a program that would seize underwater mortgages and, in effect, purchase them from mortgage holders? Finally, what are some potential down-side risks to local governments taking these actions? This review concludes not only that local governments are appropriate actors to address underwater mortgages, but also that ex post legal tools — such as eminent domain — are appropriate and effective techniques to use to address the fallout from the Financial Crisis of 2008, particularly its impact on homeowners. It also finds that the just compensation due holders of distressed, underwater mortgages, should governments seek to seize them by eminent domain, should be roughly sixty percent of the unpaid principal balance on those mortgages.