Roughly half the homeowners in the Bay Area city of Richmond are underwater on their mortgages, but city officials have come up with a plan to float them to safety, much to the consternation of banks and other moneyed interests.

The city is strongly considering using the power of eminent domain to seize the homes, which are worth less than the amount owed on the mortgage, and sell them back to the owners at fair market prices. Richmond, a poor city by most measurements, has not benefited much by the recent surge in housing prices and many of the homeowners owe three or four times as much as the home is worth, according to the New York Times.

It would be the first city in the nation to use eminent domain in this fashion. But they certainly aren’t the only city that would benefit immensely from the strategy. A lot of cities with low-income minority populations were sold a ton of predatory loans that shouldn’t have been offered, and the Times says at least two dozen are actively considering the move. That includes a handful in California, although bankrupt San Bernardino pondered the idea before dropping it earlier in the year.

Banks—which make money by selling the homes to lenders in the secondary market, who then make money by foreclosing on the homes and reselling them—have promised to block the city with lawsuits. They promise an end to lending in the city if it persists in its plan.

Richmond has already targeted 626 homes for loan modification and this is how it works, according to the Times:     

“The city is offering to buy the loans at what it considers the fair market value. In a hypothetical example, a home mortgaged for $400,000 is now worth $200,000. The city plans to buy the loan for $160,000, or about 80 percent of the value of the home, a discount that factors in the risk of default. Then, the city would write down the debt to $190,000 and allow the homeowner to refinance at the new amount, probably through a government program.”

The city and investors would take $30,000 and use it to for expenses and a small profit, while the homeowner ends up with $10,000 in equity.

The banks and secondary lenders would lose a cash cow that relies on the suffering of homeowners. The have called it illegal and unconstitutional, and an array of heavy hitters, including the Securities Industry and Financial Markets Association, the American Bankers Association and the National Association of Realtors, have lined up in opposition.

Besides threatening court action, they are seeking legislation at the state and federal level to snuff out the nascent movement, and revving up advertising campaigns to argue their case. At stake are more than just the primary mortgages. There are $450 billion in second liens and equity loans on bank books that could be affected.  

–Ken Broder

To Learn More:

A City Invokes Seizure Laws to Save Homes (by Shaila Dewan, New York Times)

Richmond California Plans to Save Families from Foreclosure Through Eminent Domain (by Mark Karlin, Truthout)

California City Seizes Homes to Save Them (by Ilyce Glink, CBS Money Watch)

California City’s Drastic Foreclosure Remedy: Seizure (by Les Christie, CNN Money)