When municipalities like San Bernardino County, California, Chicago, Brockton, Massachusetts, and Richmond California first proposed using their power of eminent domain to gain control of underwater mortgages in their localities, restructure and resell them the Federal Housing Finance Agency (FHFA) became concerned about the impact on Freddie Mac and Fannie Mae (the GSEs) and the Federal Home Loan Banks (FHLBanks). As conservator of the GSE's and regulator of FHLBanks, FHFA feared that widespread seizures of the loans (with compensation based on the value of the collateral property) would diminish asset values among all three.

On August 9, 2012 FHFA published a notice in the Federal Register soliciting public comment on "The Use of Eminent Domain to Restructure Performing Loans." On Wednesday it released a memorandum reviewing the topic, the input received, and implications for FHFA.

FHFA said it received 75 comments, almost evenly divided between supporters and opponents of the proposed use of eminent domain. Comments come from individuals in government, private sector financial institutions, labor unions, businesses, academics, and interest groups representing homeowners and businesses involved in financial markets.

The general thrust of comments fell into two categories; those supporting the use of eminent domain as appropriate for localities and effective for homeowners and those opposing it as violating law, eroding the value of existing financial obligations, and destabilizing the housing finance markets. Supporters contended that, as the mortgage securities have lost value, then a proper and fair valuation of mortgages would result in no loss to the investor but would benefit the homeowner. Further they argued that FHFA had no role to play in a local or state action. Opponents saw numerous legal issues, some center on the specific use of eminent domain and others on constitutional or financial issues in terms of upsetting existing contracts and creating uncertainty for providing and pricing capital.

From FHFA's perspective, this use of eminent domain set up a conflict between federal and state interests. In this case the interest is that of the Conservator to preserve assets and that of the regulator to ensure the safety and soundness of the FHLBanks. In such state/federal conflicts, federal interests nearly always prevail.

Assuming that a valid state interest exists and is not preempted by federal interests the legality of this use of eminent domain still remains in doubt FHFA says. Can eminent domain be utilized for intangible assets? State laws authorize eminent domain by localities and intangibility may not be covered in certain states.

Second, does taking an intangible asset that is performing and creates no threat to the community nor present any certainty it will stop performing violate the Contracts Clause of the Constitution that prohibits impairing the obligations of a contract, Since mortgage-backed securities are traded nationally and internationally, can the action of the locality be seen as a violation of the Commerce Clause which requires states not to interfere with interstate commerce unless there is a legitimate state interest, the state has chosen the least burdensome means of promoting that interest and the interest outweighs the burden on interstate commerce.

Third, since using eminent domain for underwater borrowers could target only certain areas of a community, might this raise issues about redlining and fair housing laws?

FHFA also raised a half dozen non-legal issues in its Federal Register entry including problems and costs of determining value, the lack of a uniform national structure such as programs like HAMP have and centralized oversight, liability, and ultimate limitations on the availability of credit or higher costs of credit.

FHFA concludes that, after conducting a review of law and markets and considering the public input it received the use of eminent domain by localities in the manner proposed presents a clear threat to the safe and sound operations of (the GSEs and FHLBanks) as provided in federal law and would run contrary to the goals set forth by Congress for the conservatorship.

Therefore, it says, it considers the matter one "that may require use of its statutory authorities." It says it may take any of the following steps:

• Initiate legal challenges to any local or state action that sanctions the use of eminent domain to restructure loan contracts that affect FHFA's regulated entities;

• Act by order or by regulation to direct the regulated entities to limit, restrict, or cease business activities within the jurisdiction of any state or local authority employing eminent domain to restructure mortgage loan contracts; or

• Take such other actions as may be appropriate to respond to market uncertainty or increases costs created by any movement to put in place such programs.

Translation: The FHFA will fight Eminent domain in court.  They'll cut off involved municipalities from access to Fannie/Freddie loans, and just for good measure the third bullet point is essentially saying "whatever it takes."  This isn't just another random FHFA press-release-style communication, but a memorandum signed by Alfred M. Pallard, FHFA General Counsel.