The Mortgage Bankers Association (MBA) and other industry groups have lined up considerable legal talent to prevent and block any local community from invoking eminent domain to seize and restructure underwater mortgages.

Their attorneys have assured the industry that this unprecedented use of eminent domain raises multiple questions under the U.S. Constitution and state laws. And they could contest any seizure and keep the matter bottled up in the courts.

So far, only a few communities have embraced the concept of eminent domain promoted by Mortgage Resolution Partners (MRP), a San Francisco residential finance firm.

Not one mortgage has been seized yet. But the industry is concerned that any seizure could poison the well. “What investor in their right mind would ever invest in a community that allows arbitrary writedowns of negative equity,” said MBA president and chief executive David Stevens.

“The lack of investment capital will have a direct and profound impact on every future homebuyer in that community,” he said last week at a MBA symposium on eminent domain.

To fight its battle, the industry has turned to Congress for help. Rep. John Campbell, R-Calif., has introduced a bill that would essentially cut off a community’s access to government-backed loans if local officials invoke eminent domain to seize mortgages.

It would be very difficult to get Congress to pass a bill like that. But it shows the lengths the industry will go to stop the use of eminent domain in the seizure of mortgages. Industry officials are seriously concerned eminent domain could undermine the mortgage finance system. And its use as proposed by MRP strikes a vulnerable sector of the mortgage market: private-label MBS.

The pooling and servicing agreements in private-label MBS make it difficult to engage in principal reduction modifications and provide relief for homeowners who are still current on their mortgages.

Complicating the situation is the fact that Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks hold $145 billion in private-label MBS. Moody’s Investors Service recently estimated that wide-spread use of eminent domain could cause PLS investors to suffer immediate losses as high as 30%, according to an MBA letter addressed to the GSE regulator.

The Federal Housing Finance Agency (FHFA) has already served notice that it has “significant concerns” about eminent domain and revising existing contracts. In seeking public input on the issue, the FHFA said “resulting losses from such a program would represent a cost ultimately borne by the taxpayers” that could have a chilling effect on lenders and investors.

The eminent domain proposal advanced by MRP calls for local governments to condemn underwater mortgages. Investors would then purchase mortgages and MRP would modify them through a principal reduction.

The new loans would meet Federal Housing Administration (FHA) standards for a short refinancing so they could be pooled and sold via Ginnie Mae MBS.

Campbell said several bankrupt communities in his state have been tempted to use eminent domain to assist underwater borrowers. The congressman said his bill is intended to stop the promotion of these “abusive” proposals. “If they don’t stop, we will proceed with the bill,” the California congressman warned.

The Campbell bill would prohibit Fannie, Freddie, FHA and the Department of Veterans Affairs from insuring or guaranteeing newly originated single-family loans in counties that use eminent domain.

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