Seize the mortgages, save the neighborhood

America’s failure to solve the continuing mortgage crisis is the most serious lapse in the aftermath of the 2008 subprime meltdown. Several decades of increased homeownership rates in working-class and minority communities have been wiped out. Most homeowners who lost equity, or their homes, were not speculators but innocent bystanders caught in the downdraft of the housing prices that followed.

The Obama administration’s mortgage relief program has helped only about 10% of the more than 13 million households still at risk of foreclosure because of “underwater” mortgages — those worth more than the value of the homes. The program did not target those most in need, and it can’t reach mortgages turned into securities by private Wall Street firms.

In the hardest-hit communities, the apparent firming of housing prices is mainly the result of speculators buying up vacant houses, not ordinary buyers coming back in. The missing ingredient in this dismal story is reduction of the principal owed on loans, so that people with underwater mortgages can stay in their homes.

Now, however, a more drastic approach is gaining support. Local governments could use eminent domain to take mortgage-backed securities (instead of land), pay their owners fair market value and turn the securities back into whole mortgages. For example, if a security backed by mortgages likely to default is trading at 40% of its face value, eminent domain could reduce the mortgage debt by 60%.

Richmond, Calif., where Mayor Gayle McLaughlin is a strong supporter, is on the verge of giving eminent domain a try. Nearly half of the city’s homes have mortgages worth more than the houses. Local governments in El Monte and La Puente are also exploring the idea, as are Seattle, North Las Vegas and Newark, N.J.

Eminent domain more typically is used to destroy neighborhoods for new development. In this case, it could instead save neighborhoods. If eminent domain became a general strategy, it could spare an estimated 3 million to 4 million families the loss of their homes.

The new interest in eminent domain follows some false starts. Last year, a private group called Mortgage Resolution Partners pitched its concept to several cities. MRP’s investors would provide the upfront money and legal backing for eminent domain takings, in exchange for a hefty profit.

The plan progressed the furthest in San Bernardino County, where about 168,000 homes, 43% of the total, were underwater. But local officials got cold feet, as the securities industry threatened endless litigation. There was also criticism that MRP was proposing to convert only mortgages held by homeowners current on their payments, leaving vast swaths of neighborhoods to remain vacant and blighted.

What gave the strategy new life was the direct involvement of community groups and union locals. The Alliance of Californians for Community Empowerment, or ACCE, and the national coalition of faith-based groups known as PICO, or People Improving Communities through Organizing, concluded that eminent domain could work if it protected neighborhoods and didn’t give middlemen too big a cut. Locals of the Service Employees International Union, reeling from the impact of foreclosures on its members, local tax revenues and public services, also enlisted local officials.

MRP is now working with several municipalities, including Richmond, and has signed the community groups’ statement of principles. According to ACCE campaign director Amy Schur, “The involvement of the community groups and unions assures that the deals aren’t just between investors and city hall, and produces the broad political support needed to counter the bankers.”

The large investment banks that trade securities have continued to issue threats, hoping to dissuade mayors and investors. Their trade association, SIFMA, contends that this use of eminent domain is unconstitutional and has threatened that cities considering it could pay more to sell their bonds. In fact, the Supreme Court has repeatedly upheld broad use of eminent domain, most recently in the 2005 Kelo decision.

It may seem odd that the federal government is so disengaged from fixing the foreclosure crisis that community groups are turning to friendly private investors. But there are many ways Washington could help.

Once private-label securities are converted back into whole mortgage loans, the Federal Housing Administration would need to insure them. Leftover money from the federal Troubled Asset Relief Program could perhaps help capitalize a broader eminent domain program. The Federal Reserve, which purchases distressed securities, could buy new securities that back loans with reduced principal.

It took the worst kind of creativity of the private and public sectors to produce this mess. Now, we need the ingenuity of community and labor groups working with public-minded officials and investors to solve it.

Robert Kuttner, author of the just published “Debtors’ Prison: The Politics of Austerity Versus Possibility,” is co-editor of the American Prospect and a senior fellow at Demos.