Municipal Condemnation of Mortgage Loans

• Citation: Vol. 37 No. 1
• Publication year: 2014
• Author: By John Vlahoplus*

Municipal Condemnation of Mortgage Loans

By John Vlahoplus*

INTRODUCTION

Cities across California and the nation are considering using their powers of eminent domain to purchase both performing and defaulted underwater mortgage loans (those whose principal balance exceeds the value of the encumbered home). They seek to reduce principal on the loans in order to minimize defaults, short sales and foreclosures, and thereby to mitigate the broad community costs of the negative equity crisis (the "Municipal Plan"). Many cities are specifically considering purchasing loans held in private securitization trusts, which do not benefit from any federal government guarantees.

The Municipal Plan is certainly controversial, and opponents have raised constitutional challenges and criticized it as poor policy, as unlikely to achieve its stated goals, and as providing significant benefits for private parties (including private parties that fund the loan purchases or advise cities).¹ This essay considers the applicable law in the context of the principal legal challenges to the Municipal Plan.

EMINENT DOMAIN GENERALLY

The power of eminent domain is inherent in State sovereignty, and States did not yield the power by ratifying the federal constitution.² California delegates this sovereign power to cities with few limitations.³ The power extends to all types of property, real and personal, tangible and intangible.⁴ In particular, "[a] chose in action, a charter, or any kind of contract are, along with land and movables, within the sweep of this sovereign authority."⁵ This includes mortgages. In fact, the U.S. Supreme Court has instructed States to use eminent domain when helping individual mortgagors at the expense of mortgagees furthers the public good.⁶

CONTRACT CLAUSE

Some critics claim that the Municipal Plan impairs the mortgage loan contracts and therefore violates the Contract Clause⁷ of the federal constitution. However, the U.S. Supreme Court has declared for over one hundred and fifty years that a condemnation is a purchase, not an impairment, and that the Contract Clause does not apply to eminent domain. The Court stated as recently as 1984 that the Contract Clause argument has "no merit" because the "Clause has never been thought to protect against the exercise of the power of eminent domain."⁸ As the Court explained in 1912:

The obligation of a contract is not impaired when it is appropriated to a public use and compensation made therefor. Such an exertion of power neither challenges its validity nor impairs its obligation. Both are recognized, for it is appropriated as an existing, enforceable contract. It is a taking, not an impairment of its obligation. If compensation be made, no constitutional right is violated. All of this has been so long settled as to need only the citation of some of the many cases.⁹

The rule is fundamental to State sovereignty and to our federal system of government. The Court explained in 1848 the underlying constitutional principles, which include: (1) all private rights must yield to the paramount authority of eminent domain to promote the public good; (2) contracts are no "more sacred" than land or other property in respect of a State's power of eminent domain; (3) companies are no "more sacred" than human beings in respect of a State's power of eminent domain; and (4) every contract contains an inherent term, which is presumed to be known by all, that it is subject to the power of eminent domain; therefore the power inherently cannot conflict with the Contract Clause.¹⁰

Eminent domain is so fundamental to sovereignty that a State cannot even contract away the power.

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This is true even though the Contract Clause does enforce a State's contractual agreement to forgo other important government powers, such as other police powers and the power of taxation.¹¹

TAKINGS CLAUSE

Some critics claim that the Municipal Plan violates the Takings Clause¹² of the federal constitution because it will pay less than fair value for the loans and because it lacks a public purpose. The valuation claim is false by definition. The law requires cities to pay fair value, and disagreement over price does not render a taking unconstitutional.¹³

Longstanding U.S. Supreme Court precedent supports the Municipal Plan's public purposes. The constitutional standard for evaluating a city council's action is simple: the taking is valid as long as it "is rationally related to a conceivable public purpose."¹⁴ The Municipal Plan meets this test.

Any city that adopts the Municipal Plan will determine its public purposes and will articulate them in a resolution of necessity. City councils are considering the Municipal Plan to further a number of public purposes within the traditional police power of health, safety, and welfare: reducing crime; reducing the costs of maintaining vacant properties; improving public health; increasing housing security, availability, and financing opportunities (including restoring normal lending by reducing the number of underwater loans and the shadow inventory of likely future foreclosure and short sales); and protecting their ability to provide vital community services by minimizing adverse property tax impacts (e.g., preventing long term revenue loss and inequality of tax burdens that foreclosure and short sales cause by ratcheting down Proposition 13 assessment caps for current buyers, but not for neighbors who retain their older, higher caps).¹⁵

Further, principals from academia,¹⁶ government,¹⁷ and the private sector¹⁸ have advocated using eminent domain to reduce principal, keep people in their homes, and solve the mortgage crisis. Nobel Laureate economist Robert Shiller has called the Municipal Plan an effort that "we must hope . . . succeeds."¹⁹ U.S. federal banking regulators support the focus on privately securitized loans,²⁰ and the Federal Housing Finance Agency has concluded that those loans are the "crux" of the housing crisis and must be fixed if we want to fix the mortgage crisis.²¹ Finally, including underwater performing loans in a program also meets this test, because those loans qualify for the most useful state and federal mortgage assistance programs, and the federal government has recognized that loan modifications are most likely to succeed if they are made before a default.²²

Once a city council has identified a public purpose, the council's decision is then controlling. A court cannot "substitute its judgment" of what constitutes a public purpose unless the government's declared purpose is an "impossibility"²³ or is "palpably without reasonable foundation,"²⁴ which is not the case here given the demonstrated support of economists and other experts. California law is consistent, expressly providing that the government's resolution of necessity conclusively establishes public purpose.²⁵

Nor does it matter that a private party may benefit from the city council's action; the only relevant issue is the government's actual purpose.²⁶ The mechanics of an eminent domain program may properly provide "direct and significant" benefits to private parties because public purposes "may be as well or better served through an agency of private enterprise than through a department of government. . . ."²⁷ In fact, California expressly authorizes private businesses to exercise eminent domain for their own profit where the business furthers the public good.²⁸ Finally, implementing a joint public/private effort like the Municipal Plan follows express California legislative direction. The legislature has declared a decent home for each family to be a goal of the highest priority, and it specifically directs "the private and public sectors of the economy to cooperate" in achieving that goal.²⁹

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LOCATION OF LOANS

Some critics argue that the Municipal Plan attempts to...