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Eminent Domain and Underwater Mortgages: Solving the Municipal Fiscal Crisis

Yahoo Finance

The city of Richmond, California, has taken bold action to pull the community out of the depths of the residential real estate crisis. Its approach -- using eminent domain to forestall foreclosures -- promises relief for Richmond homeowners. But it also is a template for cities across the land suffering from their own fiscal crises and facing bankruptcy.

Like so many other cities, the plunge in real estate prices that triggered the Great Recession desperately wounded the community of Richmond. Many homes carry mortgage principal exceeding the market value of the property. The obvious solution would be to write down the mortgage balances to re-align with the new market. That’s what the mortgages are actually worth anyway and it has been shown many times that such a reasonable approach is best for both the homeowner and the lender.

The problem is that it is often hard to identify an actual lender to negotiate with, given the way that mortgages were chopped up and bundled during boom times. Using eminent domain to refinance cuts through this problem.

A workable solution

A number of cities have considered the use of eminent domain. In addition to helping their citizens who were injured by the crash, the cities understand that devastated home prices undermine the financial integrity of the governments. A 2012 study by the New York Fed details how distressed properties distort the tax revenues of cities and states. It turns out that indirect damage to sales and income tax revenues is even larger than the losses in property taxes, at least initially. Property tax losses are delayed as reassessment takes time and some cities increase tax rates to compensate lowered values. But it works the same way during a recovery. The effects will linger for years in some places.

A federal initiative would make sense, but the political will is not there. The effects of the real estate bubble burst vary dramatically from one location to another. It is at the state and local level that the political motivation is at its highest. It is perfectly sensible that cities and counties take the initiative if the federal government does not.