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Eminent Domain Mortgage Battle Is a Lose-Lose Situation

Tickers in this article: IYR XHB XLF

NEW YORK (TheStreet) -- It has been called a bold, novel move to help save struggling homeowners from foreclosure.

But depending on who is talking, it has also been called drastic, desperate, ill-advised and downright unconstitutional.

The move by Richmond, Calif., to seize "underwater mortgages" from private investors using its powers of eminent domain has drawn controversy and consternation within the mortgage industry.

Eminent domain is the power of the state to seize private property for public use. The owner of the property is typically entitled to "reasonable compensation."

The law has mostly been used to seize property for public purposes such as building roads, highways or schools and other critical infrastructure.

Richmond is now testing whether the rule can be applied to seizing underwater mortgages.

Home prices in Richmond, a city with a population of a little more than 100,000 and a significant Hispanic and African-American presence, are still far below peak levels. More than half of its homeowners are underwater -- they owe more than their homes are worth.

Richmond Mayor Gayle Mclaughlin said eminent domain is the only way to help borrowers and repair the local economy, as investors of private-label mortgages have been either reluctant or too slow to provide relief to borrowers.

The city, partnering with San Francisco-based Mortgage Resolution Partners (MRP), began sending letters to owners and servicers of 624 underwater mortgages this week.

If the investors do not agree to sell at the negotiated price, the city will seize the property through eminent domain.

The mortgage industry is, predictably, threatening a legal battle.

"The practical effect of this proposal will be that individual investors, who put their money into pension funds and other investment vehicles, making mortgage money available to homebuyers, will see their assets and savings arbitrarily, and we believe unconstitutionally, taken," said Judd Gregg, CEO of SIFMA, a trade group representing the securities industry.

He added that local governments that use eminent domain to force investors to take losses on their mortgages will likely see the cost of credit rise in their communities.