The banks have filed two lawsuits alleging that the plan is an illegal abuse of eminent domain, which allows governments to seize private property for public use — like a house in the path of a new highway or a piece of land needed for a new park.
The banks argue the plan would "severely disrupt the United States mortgage industry" because many other cities would likely adopt the same program to help homeowners who owe more on their mortgages than their houses are worth.
So far, Richmond has sent out more than 600 offers, but has not yet begun any eminent domain proceedings. Newark, N.J., North Las Vegas, Nev., El Monte, Calif., and Seattle are considering similar plans, according to Wells Fargo's lawsuit.
While the housing industry is recovering slowly, Richmond, a city of roughly 100,000 people, is in the middle of a housing crisis, as plummeting home values and rising crime has left many worried that an era of urban blight is upon them.
(Read more: Private mortgage insurers back in black post-crash)
McLaughlin said cities are considering the program because they are desperate. Nearly half the mortgages in Richmond, for example, are "underwater," the owner owes more than the house is worth.
The plan is the brainchild of Cornell University law school professor Robert Hockett and here's how it works:
"The fact of the matter is that underwater loans do default at massive rates," Hockett said. "Underwater loans are a major drag on the economic recovery. We have got to do something."
Richmond, working with San Francisco-based Mortgage Resolution Partners, offers $150,000 to buy a $300,000 bank loan on a house that is now worth $200,000 and is in danger of foreclosure.
If the bank agrees, the city and the company then obtain the loan at $150,000. Richmond and the company then offer the homeowner a new loan of $190,000, which, if accepted, lowers the monthly payments and improves the owners' chances of staying.
In such transactions, the company receives $4,500 for each completed sale and splits any additional profits with the city.
If the bank refuses to sell the loan to Richmond, then the city invokes its power of imminent domain and seizes the mortgage. It would then offer the bank a fair market value for the home.
Mortgage Resolution Partners, the company partnering with the city, puts up the money and had promised to pay all Richmond's legal costs. City officials have not said how many homes they hope to refinance through eminent domain.
McLaughlin is a Green Party candidate who beat back opposition from the city's police and fire unions to win a second term in 2010.