Richmond, CA Runs Amok with Eminent Domain
Industry Update: On August 12, USA TODAY published a column titled Richmond, Calif., Runs Amok with Eminent Domain: Column.
Richmond, Calif., runs amok with eminent domain: Column
The use of eminent domain to condemn hundreds of mortgages in the California city makes no sense.
The City of Richmond, California is threatening to use eminent domain to condemn over 600 mortgages on homes that are now worth less than the outstanding debt on the mortgages themselves. The city plans to write down the value of the mortgages and transfer most of the value to the current owners of the homes.That's a move that could have nationwide implications for homeowners and those who aspire to join them if the idea spreads.
Other cities have considered similar measures, but backed away from using the legal innovation.
Various banks and investors have filed lawsuits arguing that the Richmond policy is unconstitutional. Some of their arguments have merit, but regardless of the legal problems, condemning mortgages is misguided. Advocates claim that the program will actually pay for itself. But the idea that the city will be able to strip distressed mortgages from one set of owners and sell new smaller mortgages to investors at a profit is speculative at best. If the rosy scenario doesn't materialize, taxpayers will be left holding the bag; future home buyers will suffer even if it does.
- Far from benefiting low-income people as intended, the plan will actually harm them. Much of the money to condemn the mortgages and pay litigation expenses will come from taxpayers, including the poor. Most of the poor are renters, not homeowners, so they cannot benefit from this program. But renters do indirectly pay property taxes through the property taxes paid by their landlords, a cost which is built into their rent.
- The program would also enrich those who took dangerous risks at the expense of the prudent. It isn't good policy to force more prudent taxpayers to subsidize the behavior of people who took the risk of purchasing high-priced real estate in the midst of a bubble. Doing so will predictably encourage dubious risk-taking in the future.
- Prudent Richmonders will also lose out from this policy in another way. If lenders believe that the city is likely to condemn mortgages whenever real estate prices fall significantly, they will either be unwilling to lend to future home purchasers in Richmond, or only do so at higher interest rates. That will hurt the local economy and make it more difficult for Richmonders to buy homes.
- We should also remember that eminent domain that transfers property to private parties is often used to benefit the politically powerful at the expense of the poor and the weak. In Kelo v. City New London(2005), a closely divided Supreme Court ruled that government could take private property and transfer it to influential business interests in order to promote "economic development." As a result, multiple New London residents lost their homes for a "development" project that still hasn't built anything on their former property eight years later. Property owners lost their rights and the public has yet to see much benefit.The Richmond policy would create another precedent to help legitimate future Kelos.
So long as Kelo remains in force, the Richmond takings probably won't be invalidated because they transfer property to private interests, even though the Constitution only allows takings that are for a "public use." But Richmond's plan has another constitutional defect: undercompensation. The Fifth Amendment requires the government to pay "just compensation" when it condemns property, which the Supreme Court has long interpreted as "fair market value."
The City is offering to pay lenders 80% of the home's currently assessed value, irrespective of the amount of money still owed on the mortgage, which is often far more than that. For example, if a home is currently worth $200,000 on the open market, and is mortgaged for a total of $400,000, the city would pay lenders $160,000. Even if the owner defaults, the lender can probably recover more than $160,000 through a foreclosure sale. And most of the mortgages Richmond seeks to condemn are not in default, which makes their value much higher. These are only very rough, simplified calculations. Nonetheless, it is likely that Richmond's valuation formula gives lenders much less than fair market value.
Even today, victims of eminent domain are often undercompensated. If the courts uphold Richmond's plan, that problem will get worse. If on the other hand, the city fixes this problem by increasing compensation, that would increase the burden on taxpayers and further undermine hopes the program would pay for itself.
Richmond's plan to condemn mortgages is unjust, unconstitutional, and unlikely to benefit the local economy in the long run. If other jurisdictions imitate this policy, it will also make life harder for future home buyers and potential victims of eminent domain. Professor Ilya Somin teaches constitutional law and property law at George Mason University. He is the author of Democracy and Political Ignorance: Why Smaller Government is Smarter.
To view the online column, please click here.
Safeguard Properties is the largest mortgage field services company in the U.S. Founded in 1990 by Robert Klein and based in Valley View, Ohio, the company inspects and maintains defaulted and foreclosed properties for mortgage servicers, lenders, and other financial institutions. Safeguard employs approximately 1,700 people, in addition to a network of thousands of contractors nationally. Website: www.safeguardproperties.com.