Can Eminent Domain Save the Housing Market?

The housing crisis has confounded experts for years, despite the best efforts of private parties and public governments. Now, though, a new proposal would use the government's power to take property with compensation in order to simplify restructuring mortgage loans. The proposal has drawn strong comments as proponents and opponents debate whether it can actually get the housing market moving forward.

In the past four years, investors and ordinary Americans alike have increasingly looked to the government for solutions to some of the biggest problems facing the nation. From the financial crisis to health care and housing, the government has been instrumental in exercising its power at critical times, and while those of different political ideologies would disagree about the results, few could argue that the government hasn't taken more dramatic steps recently than it has in the past. Yet the checks and balances on government power built into the fabric of the nation represent one of the biggest distinctions of the U.S. from its world peers.

The latest example of this balancing act of solving problems without overreaching government power comes in a recently proposed solution to the foreclosure crisis. Rather than letting overburdened courts go through the normal foreclosure process, the San Bernardino County government in California is considering using its power of eminent domain to force mortgage holders to sell their mortgages to the government. The government would then write down the value of the underwater mortgages, leaving homeowners in a better position to sell homes or refinance mortgages.

Predictably, though, the investors who own securities backed by these mortgages argue that the move wouldn't fairly compensate them for the value of the mortgages. Pointing out that many underwater mortgages that are still being paid on time are likely candidates for eminent domain, a Legg Mason ( LM ) bond unit representative told Bloomberg that the entire mortgage-backed securities market could see reduced interest as a result, hurting it and other bond investors.

The move wouldn't be the first controversial use of eminent domain. Historically, eminent domain required the government to pay fair value to private owners for property it took from them. More importantly, though, the Constitution requires a "public use" for the land. So there's no question that a government can appropriate land for use as a public park or some other clear example of public use.

Where problems arise, though, is where the cited public use also carries a private benefit. For instance, the Keystone XL pipeline would have required eminent domain for its construction, benefiting TransCanada ( TRP ) as the operator of the pipeline. The arguable public need for energy, though, would have triggered the right to use eminent domain. Now that rival Enbridge ( ENB ) is touting its own pipeline proposals after opposition to Keystone, the status of eminent domain definitely plays a definite role in determining winners and losers in the industry.

Big-box retailers have also been criticized for taking advantage of local governments hungry for jobs and tax revenue by using eminent domain to take private land for development. Home Depot ( HD ) , Target ( TGT ) , and Wal-Mart are just some of the retailers that have benefited from eminent domain in the past.

In the housing realm, the big fight over eminent domain would concern the valuation of the mortgages themselves. Local governments certainly don't have enough money to pay what mortgage securities holders would like for the mortgages, and they'll likely point to underwater mortgages as technically worthless in order to lowball investors. Courts haven't always made reliable assessments of fair value under eminent domain proceedings.

Moreover, just as current mortgage securities holders arguably benefit from the status quo, there would also be some private winners from the eminent domain proposal. For instance, San Francisco's Mortgage Resolution Partners, which is acting as a community advisory firm to help facilitate the proposal, says it will be paid a fee based on the volume of mortgage loans that governments acquire.

In the end, though, the only way we'll see whether eminent domain works better than the foreclosure process is for San Bernardino or some other government to try it. There are private winners and losers in every scenario, so perhaps the measure of success should focus not on the inevitable private gain, but on whether eminent domain actually thaws the frozen housing market.

Getting your own housing in order is just one part of planning for a secure retirement. Investing smarter is also important. Get some useful tips from our special report: "3 Stocks That Will Help You Retire Rich." Get your free copy today while it lasts!

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter@DanCaplinger.

Fool contributor Dan Caplinger looks at all the alternatives. He doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Home Depot and creating a bull call spread position in Wal-Mart. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy saves you.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

More Related Articles

Sign up for Smart Investing to get the latest news, strategies and tips to help you invest smarter.