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Threat of Eminent Domain Causes Freddie Mac to Take Legal Action

Written by Paul Esajian

As a contingency plan for the city of Richmond, CA, officials are intent on using the power of eminent domain to alleviate delinquent homeowners from underwater mortgages. Proponents of the idea have already begun sending letters to lenders offering to purchase the loans of properties that cost more than they are actually worth. Subsequently, said individuals have already announced that they would seek to obtain those loans through the power of eminent domain if lenders resisted selling at a price predetermined by the city.

Of particular concern to Freddie Mac, however, are the potential losses that may result from transactions of this nature. The mortgage giant stands to lose a significant amount of financial assets if Richmond is granted the power of eminent domain. In response to the recent threat, executives at Freddie Mac have weighed the option of legal action against the city of Richmond. Executives at Freddie Mack are concerned that transactions under the threat of eminent domain are no longer voluntary, violating both ethical and legal codes.

“Our sense is that so-called voluntary loan sales would not be very voluntary. They are loan sales under pressure,” said William McDavid, general counsel of Freddie Mac, on a conference call with reporters Wednesday. “We would consider taking legal action” if it had the backing of its federal regulator, he said.

Eminent domain, as its name suggests, allows the government to forcibly acquire land for public use by the respective state. The property may be taken either for government use or by delegation to third parties who will devote it to public or civic use or, in some cases, economic development. Acquired land may therefore be used for new housing, roads and even shopping centers. Those subjected to eminent domain are entitled to compensation, as determined by a court of law.

However, the city of Richmond intends to purchase the mortgages from investors at a price below the property’s current market value. In doing so, officials hope to reduce the principal on underwater loans and refinance the loan into a government-backed mortgage.

With the threat of eminent domain looming, Freddie Mac is particularly concerned with the loans that were previously pooled together and sold to investors as mortgage-backed loans. The resulting private-label securities do not have any form of government backing, as they were issued by Wall Street-firms and not Fannie Mae or Freddie Mac.

City officials in Richmond, in association with Mortgage Resolution Partners, have identified approximately 624 mortgages that could potentially be acquired through the power of eminent domain. Of those, 444 properties are currently on top of their payments. Conversely, 180 of the homes are delinquent.

The proposal of eminent domain has taken traction with local community activists. Proponents of the idea believe it will assist homeowners in the reduction of their debt and help them avoid foreclosure. The high rate of underwater mortgages in Richmond is already damaging the housing sector and reducing the fundamental value of local property. “It’s the responsibility of banks to fix this, and they haven’t, so we’re taking it into our hands,” said Richmond Mayor Gayle McLaughlin last week.

While popular with local residents, mortgage investors currently holding the loans are outraged at the prospect of eminent domain. More specifically, investors are worried that the city will offer too little to acquire the loans, causing them to lose money. They also say that seizing loans would upend their expectations of loan performance that is used to determine how much they pay for those bonds.