San Francisco-based Mortgage Resolution Partners (MRP) has been pitching a scheme to get distressed cities to use their right of eminent domain to seize underwater homes and pay MRP to help restructure the mortgages. They tried and failed in several cities before finding a receptive audience in North Las Vegas. Naturally, city officials want to help their constituents, who have been hit hard by the recession and the collapse of the housing market, but the agreement they signed with MRP on June 19 goes against both the U.S. and the Nevada Constitutions, puts the city at risk of losing even more money, and could further damage the local housing market.

Under their plan, MRP would identify homeowners who are underwater yet still current on payments, and whose mortgages were financed by private investors and bundled into mortgage-backed securities. Using its power of eminent domain, the city would forcibly take over the properties and pay the current mortgage holders pennies on the dollar. The city could then re-sell the homes back to their current owners at a price closer to market value, assuming the owners could qualify for a new loan. MRP estimates about 5,000 homes in North Las Vegas would qualify for their plan.

As an example, the city takes over a home with a $300,000 note and pays the original mortgage holder only $150,000. Then MRP finds a buyer for a new note at $190,000. Theoretically, the city would make $40,000 (less fees) and the homeowner’s mortgage is now $190,000 instead of $300,000. But what about the holder of the original note? In effect, the city is using its power of eminent domain to take $150,000 away from that investor. These mortgage-backed securities are owned by everyday citizens who have put their savings into investment funds. Why should they lose their investment in order to benefit the underwater homeowner, the city government and MRP?

This “feel-good” proposal is wrong on so many levels. It violates the Nevada Property Owners’ Bill of Rights, which was incorporated into Article One of the Nevada Constitution and bans the use of eminent domain to transfer property between private owners. The agreement also violates the due process guarantees of the Fifth Amendment of the U.S. Constitution and the equal protection guarantee of the 14th Amendment.

Implementing the plan could be costly and carries a lot of risk. MRP is charging $4,500 for each mortgage, and the city would also be responsible for interest and servicing costs. There’s no guarantee that third parties will purchase the new loans. If 5,000 homes qualify for the plan at $150,000 per mortgage, the city could be on the hook for $750 million. And what happens while the city is holding all these mortgages waiting for new investors to appear? Who collects the mortgage payments and handles delinquencies? Does the city really need another bureaucracy?

Investors who currently hold mortgages could sue the city, which could be responsible for court costs. One North Las Vegas citizen, Gregory Smith, has already filed a federal suit in U.S. District Court, asking the court to declare the plan unconstitutional.

This plan would have repercussions for the entire area by making private lenders unwilling to make loans here. And proposed legislation in Congress (Protecting American Taxpayers and Homeowners Act of 2013) would bar federally backed loans in any county where eminent domain is used for mortgage relief.

The agreement with MRP contains a clause allowing the city to back out of the agreement at any time. When the City Council meets on August 21 it should cancel the contract before it gets in any further trouble. While we feel for the people who are stuck in underwater homes, the first rule of lifesaving is not to let the drowning person pull you under, and this is just what’s likely to happen if North Las Vegas continues with this unconstitutional and dangerous scheme.

By Whose Authority?

For more information on my Commentary and to see some of the backup research, or if you wonder why I take the position I take, go to www.LyleBrennan.com.