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California City Moves Ahead With Eminent Domain Mortgage Plan Despite Risks (Update 1)

Tickers in this article: BLK DB WFC
Updated from 11:11 a.m. ET with comments from SIFMA.

NEW YORK (TheStreet) -- The city council of Richmond, Calif. has voted in favor of moving ahead with a proposal to seize underwater mortgages from bond investors through eminent domain, despite the likelihood of a long legal battle.

The council voted 4-3 in favor of the "Richmond CARES" program, under which the city, in partnership with a firm called Mortgage Resolution Partners, seeks to buy 624 underwater mortgages held by private investors at a discount to the underlying property value, write them down and refinance them. If investors do not voluntarily sell, the city will seize it through eminent domain.

Still, there were clearly concerns among some officials that the plan came with considerable risks. The mortgage industry, including the Federal Housing Finance Agency which regulates Fannie Mae and Freddie Mac, has threatened to cut off Richmond if it uses eminent domain to seize mortgages.

Recently, the city had trouble finding takers for a municipal bond offering in August.

And the legal battle could be lengthy and costly for the city, with eminent domain cases typically taking two years in court and appeals taking even longer.

"A 1 percent chance of bankruptcy from this program is a deal-breaker for me," Councilman Jim Rogers said at the city council meeting, according to Reuters.

Eminent domain allows government to seize private property for public use for fair compensation.

Richmond officials argue it is the only way they can prevent further foreclosures in the city where more than half of the borrowers owe more than their mortgages are worth and are arguably at risk of default.

The mortgage industry has promised a fierce fight, arguing the proposal is unconstitutional and ill-advised, especially because many of the 624 mortgages that the city plans to write down are current and the offer from Richmond is well below what the investors consider to be the fair market value of the loan. Moreover, nearly 40% of those loans have already been modified.

Critics say the plan does not really benefit the public and that Mortgage Resolution Partners, which earns a fee for every mortgage refinanced under the program, stands to unfairly profit at the expense of bond investors.