The Federal Housing Finance Agency (FHFA) will post a notice in the Federal Register on Thursday announcing that it was open to input from any persons with views on the subject of eminent domain as a mechanism to restructure performing loans.  The agency thereby entered the growing controversy around the subject.

As background, in June the Board of Supervisors in San Bernardino County California announced a Homeowner Protection Program in which they proposed to use their power of eminent domain to take underwater mortgages from lenders and restructure them for borrowers at the fair market price.  Officials in Berkeley, California and Chicago subsequently passed similar measures. 

The San Bernardino action immediately triggered a response from SIFMA, the trade organization representing the securities industry, protesting the proposed actions and indicating that such an action would trigger litigation against the local governments and ultimately backfire on the communities' borrowers, limiting credit in the future.  In response to those comments, California Lieutenant Governor Gavin Newsom politely told SIMFA to shut up.

FHFA has now expressed its concern over the proposals.  Citing its role as conservator of Freddie Mac and Fannie Mae (the GSEs), FHFA said its obligation is to preserve and conserve the GSE's assets and to minimize costs to taxpayers.  These entities purchase a large portion of the mortgages originated in the U.S. the notice says, and they hold private label mortgage backed securities containing pools of non-GSE loans.  The Banks also have large holdings of such securities and accept collateral that consists of mortgages of member financial firms pledged in exchange for advances of funds.   

The notice, signed by FHFA COO Richard Hornsby says the agency has significant concerns about the use of eminent domains to revise existing financial contracts and the alternation of the value of GSE or bank securities holdings.  In the case of the GSEs resulting losses would ultimately be borne by taxpayers.  FHFA also expressed concern that the programs could undermine and "have a chilling effect" on the extension of credit by investors that support the housing market.

The agency said it has determined that it might need to take action both as conservator of the GSEs and regulator for banks to avoid a risk to safe and sound operations and avoid taxpayer expense.  The proposed use of eminent domain raises issues about the constitutionality of such an action, the application of federal and state consumer protection laws, the effects on holders of existing securities and on millions of negotiated and performing mortgage contracts.  There are also issues regarding the role of the courts in administering or overseeing such a program and, in particular, critical issues surrounding the valuation by local governments (as is typical in eminent domain proceedings) of complex contractual arrangements that are traded in national and international markets.

Anyone wishing to comment can do so through the FHFA Office of General Counsel on or before September 7.