Richmond, Calif., made headlines this year when city officials began considering a plan to use eminent domain to take over underwater mortgages. The proposal would force banks to sell the mortgages at a loss, though at current market values. Then a firm hired by Richmond would fund and finance new mortgages at reduced rates for the current homeowners.
"It's designed to prevent foreclosures, keep people in their homes, stabilize our neighborhoods and give our local economy a chance to recover," said Mayor Gayle McLaughlin.
So far, however, such novel use of eminent domain in this city east of San Francisco has remained little more than a threat, and rather than helping the housing market, it may be causing further damage.
"Several transactions have collapsed," said veteran real estate agent Jeffrey Wright, an outspoken critic of the plan. He said lenders are wary of making loans in a city where eminent domain could be used to break a contract.
The Federal Housing Administration could prevent Freddie Mac and Fannie Mae from lending where such a plan is approved. At the same time, Wright claimed he knows of at least one seller who has pulled out of a short sale, hoping he can keep his home if the eminent domain plan goes through.
"There's a very high likelihood that this person could lose their property, when they could have sold it on a short sale," said Wright, "because they're waiting on a program that's not up and running, and may never be up and running."
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Richmond hasn't formally started eminent domain proceedings because the city council needs a "supermajority," five out of seven votes, to enact the plan. The last vote was 4-3. However, council members did agree to a contract with a company called Mortgage Resolution Partners (MRP) to find homes with mortgages the city might want to take over if eminent domain is ever used.
MRP drew up a list of 624 houses with underwater mortgages. The city asked banks to voluntarily sell the mortgages at a discount, but so far, there have been no takers. Critics point out that some of the homes are worth $1 million, and many of the mortgages are current.
"Some of these homes are not delinquent," the mayor admitted. Still, "People are basically hanging on by their fingernails."
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Lenders have sued to stop Richmond's plan, but a court ruled it's too early to pass judgment, as the program hasn't even been approved.
Other cities are considering a similar use of eminent domain, the latest being Irvington, N.J. But other struggling municipalities have looked at the idea and decided against it, fearing expensive litigation.
"Chicago has rejected it," said Tim Cameron of the Securities Industry and Financial Markets Association, a leading industry trade group for banks. "Brockton, Massachusetts, looked at it and rejected it, and, most recently, North Las Vegas has examined it and has decided that it's not for them."
Cameron's group has been helping the banks fight Richmond in court. Wells Fargo is among a leading group of investors that claim they could lose $200 million on the 624 mortgages.
"We think that it's really, really outrageous for the banks to stand in the say," McLaughlin said. "We've waited for years for the banks, the federal government to step in and provide a solution. It hasn't been forthcoming, so the city is doing this common sense fix."
Cameron countered, "Keep in mind the vast majority of the people that they're looking to negotiate with on these 624 loans are actually current on their mortgage payments, so these aren't individuals who are near default, or who are about to be foreclosed upon, who are in the most need of help."
To be sure, there are plenty of houses in Richmond where people need help. A half decade into the housing collapse, the city is still drowning in underwater mortgages and foreclosures.
"We had nearly 1,000 in Richmond alone last year," said McLaughlin. She said it costs the city $19,000 in fees for every foreclosure, and refinancing some mortgages through eminent domain could save Richmond millions of dollars.
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At a meeting scheduled for Dec. 17, she'll be pushing to establish a joint powers authority with other California cities in order to push for eminent domain with more clout.
"We're looking to join with El Monte in California" she said. "We have San Francisco, Oakland looking at the program."
Real estate agent Jeffrey Wright hopes the mayor fails.
"Any time you have an involuntary and hostile set of circumstances, there's likely to be adverse consequences," he said. "I'm concerned that people are going to lose property waiting on a program that in all likelihood will never come to fruition."
—By CNBC's Jane Wells. Follow her on Twitter: