From HW:

The Securities Industry and Financial Markets Association released a legal memo on Tuesday drafted by law firm O’Melveny & Myers at the request of the association that addresses what it says are legal and constitutional problems with the infamous eminent domain proposal out on the west coast.

The association then held a conference call in which it gave three reasons why it thinks the proposal does not provide an overall public good, which it must — by law:

It does nothing to help homeowners who are behind on their payments and are in foreclosure. Only performing loans in private-label securities will be seized. “This will do little or nothing to prevent public blight in any of the neighborhoods. So it does not provide a public good,” SIFMA noted;

It doesn’t maximize the value of properties in question and that it just transfers wealth from one investor to a more aggressive short-term investor; and

Investors would be forced to revalue mortgage pools based on the possibility of government seizure. These losses, SIFMA says, would reduce access to credit for mortgage borrowers in San Bernardino county by increasing interest rates. And reduced access to mortgages would reduce the demand for homes, putting downward pressure on housing prices.

The idea, headed by venture capital firm Mortgage Resolution Partners, does not go after defaulted or delinquent loans, where the property at issue might be subject to a imminent threat of blight. The proposal instead is limited to performing loans secured by underwater homes on the theory that forcibly transferring and discounting them will reduce the risk they could default and lead to future blight.

The legal memo cites several cases that SIFMA thinks pokes holes in the idea’s satisfaction of the public use criteria.

Among them is 99 Cents Only Stores v. Lancaster Redevelopment Agency. In that case, a city attempted to condemn property owned by a discount outlet so it could be transferred to a bigger, fancier retailer. The city argued that the transfer served a public purpose because it would keep the larger retailer within the city’s boundaries and thereby prevent future blight. The court rejected that contention, finding no authority for the “novel legal proposition that the prevention of future blight is a legitimate public use.”

If preventing future blight were a legitimate public purpose, the government could condemn any property because no site can ever be truly free from blight because blight remains ever latent, ready to surface at any time. That analysis is especially applicable here, SIFMA says, given that the MRP proposal targets only performing mortgages, or notes not likely to result in the blight that is proffered as a justification for the taking.

And the proposal seems likely to raise other housing-related problems for county residents.

“As we understand it, potential lenders are already warning that if San Bernardino County adopts the plan, the market will impose substantial costs on new loans to county residents, since such loans will be subject to the new and highly unusual uncertainty that they could be seized by the government at a very significant discount from face value even when they are performing,” SIFMA says.

Given past cases and the potential for public harm resulting from the proposal, a Herculean task awaits proponents of the movement in proving that the loan transfers are necessary to create a net public good.

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