California Eminent Domain Isn't Government Run Amok
To judge from the disparaging reaction to its plan to use eminent domain to cope with underwater homes, you'd think the city leaders of Richmond, California, had proposed an outrageous and unprecedented distortion of state power.
Filing suit against Richmond, BlackRock Inc., Pacific Investment Management Co. and other plaintiffs alleged that the city's proposal amounts to an "unconstitutional application of eminent domain" and a "brazen scheme." The Federal Housing Finance Agency announced that it was considering ceasing to do business in municipalities that pursue this course. Media coverage generally echoed the plaintiffs' take. USA Today's headline summed up the conventional wisdom, declaring that Richmond "runs amok with eminent domain."
In fact, the city's plan relies not on a novel use of eminent domain but on one endorsed by the conservative Supreme Court of 1935. And although there is a long history of excessive use of eminent domain, Richmond's plan has no place in it. Richmond's plan is to seize 624 mortgages valued at more than the homes for which they were written. Relying on a private intermediary, the city would compensate the investor holding a mortgage at a price reflecting the home's current value rather than an inflated bubble value. The city would then sell a more modest loan to the homeowner. Richmond hopes this will induce residents to remain in their homes and pay their mortgages and property taxes. Proponents of the plan also point out that this probably will lower the risk of default, protecting investors holding the mortgages.
Nonetheless, the big players in the bond markets are angry that they're being forced to accede to the demands of a small city in California. Before they fight city hall, the plaintiffs should appreciate that use of eminent domain to seize intangible assets like mortgages has a solid history. Federal courts have long sanctioned the taking of everything from shares of stock to contract rights, insurance policies and even hunting rights.
But mortgages? Yes. Consider a famous Supreme Court case from the Great Depression. During that crisis, banks foreclosed on farmers who fell behind on their mortgage payments. In response, Congress passed the Farm Bankruptcy Act granting farmers five years to negotiate a reduction in the principal of their loans. Farmers were entitled to buy the property at the current appraised value, even if it fell short of the value attached to the original mortgage.
Then, as now, banks didn't like the policy and went to court, arguing that it violated their property rights, as guaranteed under the Fifth Amendment. In May 1935, the Supreme Court overturned the law in a unanimous decision, the first of several such rulings that made the court into a conservative counterweight to the New Deal. Nevertheless, in the final paragraph of its decision, the court laid out an alternative course for just the kind of remedy the Farm Bankruptcy Act had sought.
Justice Louis Brandeis observed, "If the public interest requires, and permits, the taking of property of individual mortgagees in order to relieve the necessities of individual mortgagors, resort must be had to proceedings by eminent domain."
In effect, the court stated that if the government wished to modify loans, it could only do so via an eminent domain proceeding of precisely the sort now being contemplated in Richmond. Brandeis didn't think this a particularly controversial point; he made no effort to defend it or explain his reasoning because it was an established doctrine.
And so it remains today: Intangible assets have again and again been deemed fair game for eminent domain proceedings, so long as "just compensation" is given. In California, the state Supreme Court has taken a similar stance: A decision in 2008, for example, affirmed longstanding precedent that the state's eminent domain law "authorizes the taking of intangible property."
None of this is to suggest that eminent domain hasn't been abused. In the postwar era, however, its victims have not been investors but poor, black, inner city residents.
The case that opened the door to mass evictions and confiscations was Berman v. Parker, decided by the Supreme Court in 1954. In it, a black department store owner in the District of Columbia sued to stop an eminent domain proceeding against his profitable business, which had the misfortune of being situated in an area designated as blighted.
The court rejected Berman's protest, defining eminent domain in remarkably broad terms. If the public interest demanded that his property be torn down with less desirable properties to rescue an entire neighborhood from blight, it ruled, there was nothing Berman could do. His store was soon reduced to rubble. While many urban planners celebrated the decision, Harvard Law School Professor Charles Haar was more prescient, noting that the ruling "may cause a lot of trouble some day."
This was an understatement: in the ensuing years, municipalities across the country used and abused their powers to confiscate the property of poor, often black residents, rarely giving "just compensation." Entire, thriving neighborhoods vanished before the wrecking ball, destroying communities and leaving behind gaping holes in the urban fabric that remain eyesores in many cities today.
This didn't end with the 1960s. In 2005, the Supreme Court handed down its controversial decision in Kelo v. City of New London. The case grew out of efforts by New London, Connecticut, to use eminent domain to evict working-class residents from a neighborhood in the hopes of handing the land to a private developer who promised to attract more affluent residents with a mixed-use project. The court ruled in favor of the city, vastly expanding the powers of eminent domain. The project foundered during the financial crisis and today remains a series of vacant lots, monuments to an extreme vision of eminent domain.
These are examples of eminent domain "run amok." Yet to listen to the hysterical denunciations of the Richmond plan, a proposal to bring 624 mortgages in line with market prices is the epitome of eminent domain abuse. History suggests otherwise.
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Stephen Mihm at email@example.com