(Reuters) - Some of the most powerful mortgage investors in the United States are lining up against a plan by several California local governments to forcibly purchase distressed mortgages to keep struggling residents in their homes.
Eighteen investment trade groups - including the Association of Mortgage Investors, Securities Industry and Financial Markets Association, American Bankers Association and the Investment Company Institute - sent a letter late Thursday warning the plan could prove counterproductive by scaring away future mortgage financing in those areas.
San Bernardino County and some of its towns have set up a joint authority that would use the power of eminent domain to forcibly purchase distressed mortgages. Rather than evict homeowners through foreclosure, the public-private entity would offer residents fresh mortgages with reduced debts.
"We believe that the contemplated use of eminent domain raises very serious legal and constitutional issues," the 18 organizations said in their letter to the city governments of Fontana and Ontario, Calif., and the county of San Bernardino, Calif.
"It would also be immensely destructive to U.S. mortgage markets by undermining the sanctity of the contractual relationship between a borrower and creditor, and similarly undermining existing securitization transactions."
The letter continued, "Such an action would likely significantly reduce access to credit for mortgage borrowers in the San Bernardino area and other areas that undertake similar actions."
The idea of using eminent domain to buy up mortgages that are underwater is being pushed by San Francisco-based Mortgage Resolution Partners, a firm backed by West Coast financiers.
The group's idea of raising private money to help community's condemn mortgages worth more than a person's home was first reported by Reuters.
Over the years, governments have used eminent domain authority to clear urban slums or seize land to build highways and bridges. But the power to do this is often controversial because landowners don't have much negotiating power. And in this case, potentially even more controversial since it has never been used to seize mortgages held by private investors or financial institutions.
The 18 organizations said if eminent domain were used to seize loans, investors in these loans through mortgage-backed securities or their investment portfolio would suffer "immediate" losses and likely be reluctant to provide future funding to borrowers in these areas.
"It is essential to remember that investors in mortgage-backed securities channel the retirement and other savings of everyday citizens through their investment funds," they said.
"This program may cause loans to be excluded from securitizations, and some portfolio lenders could withdraw from these markets. In other words, this program could actually serve to further depress housing values in the county by restricting the flow of credit to home buyers."
Steven Gluckstern, the head of Mortgage Resolution Partners, said the group is also talking to local officials elsewhere in California and in Nevada and Florida about using eminent domain to seize underwater mortgages.
Gluckstern, a former owners of the New York Islanders hockey team and a financier, is on a bit of a road show trying to sell the novel idea, which recently won the backing of Yale University economist Robert Shiller in an op-ed in The New York Times.
This week, Gluckstern was in Washington, D.C., meeting with some lawmakers to discuss the merits of the plan.
In an interview earlier this week before the financial trade associations sent their letter, Gluckstern said he felt any opposition to the plan could be dealt with and the group was willing to talk to bond investors and banks about the idea.
Reporting By Matthew Goldstein and Jennifer Ablan; Editing by Tim Dobbyn