Eminent Domain Calls Down Thunder From FHFA

Whenrnmunicipalities like San Bernardino County, California, Chicago,rnBrockton, Massachusetts, and Richmond California first proposed usingrntheir power of eminent domain to gain control of underwater mortgagesrnin their localities, restructure and resell them the Federal HousingrnFinance Agency (FHFA) became concerned about the impact on FreddiernMac and Fannie Mae (the GSEs) and the Federal Home Loan Banksrn(FHLBanks). As conservator of the GSE’s and regulator of FHLBanks,rnFHFA feared that widespread seizures of the loans (with compensationrnbased on the value of the collateral property) would diminish assetrnvalues among all three. </p

OnrnAugust 9, 2012 FHFA published a notice in the Federal Registerrnsoliciting public comment onrn”The Use of Eminent Domain to Restructure Performing Loans.” OnrnWednesday it released a memorandum reviewing the topic, the inputrnreceived, and implications for FHFA.</p

FHFArnsaid it received 75 comments, almost evenly divided betweenrnsupporters and opponents of the proposed use of eminent domain. Comments come from individuals in government, private sectorrnfinancial institutions, labor unions, businesses, academics, andrninterest groups representing homeowners and businesses involved inrnfinancial markets. </p

Therngeneral thrust of comments fell into two categories; those supportingrnthe use of eminent domain as appropriate for localities and effectivernfor homeowners and those opposing it as violating law, eroding thernvalue of existing financial obligations, and destabilizing thernhousing finance markets. Supporters contended that, as the mortgagernsecurities have lost value, then a proper and fair valuation ofrnmortgages would result in no loss to the investor but would benefitrnthe homeowner. Further they argued that FHFA had no role to play inrna local or state action. Opponents saw numerous legal issues, somerncenter on the specific use of eminent domain and others onrnconstitutional or financial issues in terms of upsetting existingrncontracts and creating uncertainty for providing and pricing capital.</p

FromrnFHFA’s perspective, this use of eminent domain set up a conflictrnbetween federal and state interests. In thisrncase the interest is that of the Conservator to preserve assets andrnthat of the regulator to ensure the safety and soundness of thernFHLBanks. In such state/federal conflicts, federal interests nearlyrnalways prevail.</p

Assumingrnthat a valid state interest exists and is not preempted by federalrninterests the legality of this use of eminent domain still remains inrndoubt FHFA says. Can eminent domain be utilized for intangiblernassets? State laws authorize eminent domain by localities andrnintangibility may not be covered in certain states. </p

Second,rndoes taking an intangible asset that is performing and creates nornthreat to the community nor present any certainty it will stoprnperforming violate the Contracts Clause of the Constitution thatrnprohibits impairing the obligations of a contract, Sincernmortgage-backed securities are traded nationally and internationally,rncan the action of the locality be seen as a violation of the CommercernClause which requires states not to interfere with interstaterncommerce unless there is a legitimate state interest, the state hasrnchosen the least burdensome means of promoting that interest and therninterest outweighs the burden on interstate commerce.</p

Third,rnsince using eminent domain for underwater borrowers could target onlyrncertain areas of a community, might this raise issues about redliningrnand fair housing laws?</p

FHFArnalso raised a half dozen non-legal issues in its FederalrnRegister entry includingrnproblems and costs of determining value, the lack of a uniformrnnational structure such as programs like HAMP have and centralizedrnoversight, liability, and ultimate limitations on the availability ofrncredit or higher costs of credit.</p

FHFArnconcludes that, after conducting a review of law and markets andrnconsidering the public input it received the use of eminent domain byrnlocalities in the manner proposed presents a clear threat to the safernand sound operations of (the GSEs and FHLBanks) as provided inrnfederal law and would run contrary to the goals set forth by Congressrnfor the conservatorship. </p

Therefore,rnit says, it considers the matter one “that may require use of itsrnstatutory authorities.” It says it may take any of the followingrnsteps:</p<ul<li

Initiaternlegal challenges to any local or state action that sanctions the usernof eminent domain to restructure loan contracts that affect FHFA’srnregulated entities; </p</li<li

Actrnby order or by regulation to direct the regulated entities to limit,rnrestrict, or cease business activities within the jurisdiction ofrnany state or local authority employing eminent domain to restructurernmortgage loan contracts; or</p</li<li

Takernsuch other actions as may be appropriate to respond to marketrnuncertainty or increases costs created by any movement to put inrnplace such programs. </p</li</ul

Translation: The FHFA will fight Eminent domain in court.  They’ll cut off involved municipalities from access to Fannie/Freddie loans, and just for good measure the third bullet point is essentially saying “whatever it takes.”  This isn’t just another random FHFA press-release-style communication, but a memorandum signed by Alfred M. Pallard, FHFA General Counsel.

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