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From Banking and Finance Law Daily, August 8, 2013

FHFA pledges to block use of eminent domain to restructure mortgages

By Richard A. Roth, J.D.

The Federal Housing Finance Agency essentially has drawn a line in the sand in its effort to prevent local governments from using their eminent domain authority to restructure mortgage loans owned or insured by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks (the GSEs). Asserting that such action by local governments would present “a clear threat” to the safe and sound operations of the GSEs and be contrary to the purpose of the Fannie Mae and Freddie Mac conservatorships, the FHFA has made clear its willingness to use its legal authority to block local governments from using their eminent domain authority and punish communities that do so.

Some local governments are considering using their eminent domain authority to condemn the outstanding mortgages on homes if the market value of the home is less than the loan balance—in common language, if the loan is underwater. The loan owner would be paid the fair market value of the loan, which then would be written down to the home’s market value. The new mortgages then could be securitized. The goal of the plan is to reduce the risk of defaults, including the risk of strategic defaults.

The FHFA is concerned that this process would disrupt the home finance market because investors would become uncertain about whether loans they had purchased, or that supported mortgage backed securities they had purchased, would be taken by a local government. The agency is equally worried that condemnation would reduce the value of the loans and securities held by the GSEs.

FHFA threats. The FHFA outlined three possible responses to a local government’s use of eminent domain to restructure mortgage loans. It may:

  • challenge the government action in court;
  • issue an order or regulation instructing the GSEs to limit or end their business activities within the jurisdiction of the governmental unit; or
  • take such other actions as may be appropriate” to address any market uncertainty or increased costs that result from the local government action.

General Counsel memo. The FHFA announcement was accompanied by the release of a memorandum issued by the agency’s General Counsel that included a long list of objections to the plan. The memo questioned the authority of local governments to condemn property if doing so would interfere with federal government activities, and it also raised a number of uncertainties about how a restructuring program would operate and what effects it would have.

The memo cast some doubt on whether eminent domain could be used to take intangible property such as a mortgage loan; however, its most serious question was whether a local government action that conflicted with a federal government interest would be legal. Restructuring loans in the manner proposed would reduce the value of and income from GSE assets the FHFA was obligated to preserve and conserve, the memo pointed out. It also would clearly interfere with the FHFA’s actions as conservator.

Assuming that the local government eminent domain authority was not preempted by federal law, the memo raised, without answering, a number of questions that drew attention to the uncertainties that would result from the restructuring plan. These include:

  • Can eminent domain be used to acquire intangible property?
  • Could a local program violate fair housing or other anti-discrimination laws?
  • How could fair market values be determined for loans that are underwater but still performing?
  • Would the absence of a consistent, nation-wide program result in uncertainty and multiple legal challenges?
  • Would the programs result in a fundamental change in the business of home financing?
  • Would restructuring of some loans call into question the value of all loans held or insured by the GSEs?

Companies: Fannie Mae; Freddie Mac

RegulatoryActivity: GovernmentSponsoredEnterprises Mortgages Preemption

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