Is It Illegal Under Federal Law to Opt Out Of Jurisdictions Exercising Eminent Domain?

By: Laurence E. Platt

Is a refusal to make or buy residential mortgage loans from jurisdictions that seize loans through eminent domain a federal crime or a reasoned response to excessive government intervention? That’s the question that people are asking today in light of the comments of Lt. Governor of California Gavin Newsom. Yesterday, he asked the U.S. Department of Justice to investigate and prosecute those in the industry who advocate staying away from jurisdictions exercising eminent domain. Did he expect the industry instead to send thank you notes?

Not surprisingly, the lending industry has reacted unfavorably to the proposed plans of San Bernardino, California and other state and local government entities to seize residential home mortgages from unwilling investors through eminent domain. The local governments intend to offer permanent principal write downs to consumers to aid their efforts to refinance into lower interest rates, which would be fine if the local government owned the loans in question. No worries, the local government will just seize the loans, paying what they believe is fair compensation to investors that either don’t want to sell their loans or that do not have the legal authority under their private securitization documents and REMIC rules to sell the loans. Of course, the government authorities in question don’t have the money to do this. No worries, they have a private “sugar daddy” that will provide the funds for a hefty profit. While there are significant constitutional and other legal hurdles that the governments would have to overcome to implement their controversial plans, the industry is not sitting around waiting for the courts to decide.

Instead, various segments of the lending industry have indicated that they may be unwilling to make or buy loans that are secured by properties in jurisdictions that repudiate mortgage contracts. The California Lt. Governor believes that the lending industry simply should accept these so-called legitimate seizures, because it is the fault of the lending industry that the government has to act in the first place and, in any event, the law of eminent domain has been around for years. He asks the Department of Justice to investigate for alleged unlawful collusion and redlining.

Different companies may evaluate risk in different ways, but it is certainly a reasonable business response for an investor to opt out of jurisdictions where the local government is perceived to be overreaching. If a government believes it has a call option or unilateral right to buy the loans from an unwilling investor and has shown a willingness to exercise that right, why should a lender or an investor be required to play along in the future? That’s like a country expropriating a foreign-owned business for purported public purposes and then expressing outrage that the same and other foreign businesses refuse to invest any more in their country. Of course, I’ve never heard a foreign head of state threaten legal action against an expropriated company’s refusal to invest any further in that country. Companies always take risk, including political risk, into consideration in making investment decisions, and trying to coerce companies to do business in hostile environments through threats of litigation is not likely to be effective and may well be counterproductive.

Quite frankly, I am puzzled by the request for a federal investigation. The refusal of industry participants to make or buy loans in a geographic area where the local government makes a mockery of mortgages is understandable. Litigation ultimately may vindicate the legal position of state and local governments, but some leading constitutional scholars think otherwise; final judicial resolution may take years. That does not mean, however, that any individual lender or the industry more generally has to agree to subject itself to such a risk of loss. There is no federal or state law of which I am aware that obligates any person to be a chump.

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