Here's One Way to Resolve Housing Mess, But Is It Legal?

Imagine if you were told your mortgage had been seized by the county in which you live.

You have been paying on this mortgage, but you owe more than your home is currently worth. Imagine if you were then told that the size of your mortgage had been reduced to that current value, so your monthly payments are now lower.

Jackpot! Right?

Tooga | Stone | Getty Images

That’s just what could happen, as county officials in San Bernardino County, California Friday looked into the possibility of using the powers of eminent domain to seize underwater mortgages and cut their principal balances.

Some legal experts say it is possible, but it will surely be contested.

It is an unprecedented use of eminent domain, but these are unprecedented times in the housing and mortgage markets. Governments usually use eminent domain to take property from a private owner in order to turn it around and build something useful for the public good. It has been used to get rid of neighborhood blight.

Still, the government must pay the owner fair value, and that’s where all this gets tricky, because home values right now affect more than just the homeowner. They are the foundation of billions of dollars’ worth of mortgage-backed securities. Remember, that’s how we got in trouble in the first place.

The mechanics are tricky as well. The plan is backed by a San Francisco-based venture capital firm, Mortgage Resolution Partners, which would stand to profit from buying and reselling these loans. It would raise money first to pay off the original owners of the loans, private label investors, at the reduced amount (the fair market value determined by a judge).

The arguments are vast and varied for and against. An op-ed in the Wall Street Journal opposing it:

In this instance, the government has every economic incentive to underpay the investor who owns the mortgage to cover transaction costs and boost returns for itself and MRP. Even worse in this case, the government would be grabbing mortgages on which the homeowner is still paying the monthly rent, not mortgages that are in default or close to it. It's an arbitrary seizure.

It also argues that this would put in question the values of all home loans, which could hurt home prices and keep private investors from returning to the mortgage market (not that they’re coming back in droves now as it is).

Joe Nocera in the New York Times supporting it:

It would be a way to break the logjam that keeps mortgages in mortgage-backed bonds — securitizations — from being modified. It could prevent foreclosures. And it could finally stabilize housing prices.

Borrowers would have to be current on their mortgage payments to be eligible for this, so it wouldn’t help cure any of the already delinquent loans.

The idea is that if this worked in San Bernardino, it could spread nationwide. As the idea develops, the only thing we can know for sure is that this case will end up in court before anyone seizes anyone else’s home loan.

— By CNBC's Diana Olick

Questions? Comments? RealtyCheck@cnbc.comAnd follow me on Twitter @Diana_Olick