WASHINGTON Fannie Mae and Freddie Mac may be barred from buying home loans in cities that are threatening to use "eminent domain" legal powers to seize mortgages, their regulator said on Thursday.
The Federal Housing Finance Agency, which oversees the firms, recently said it is discussing legal action against the city of Richmond, California, to try to prevent the city from using eminent domain to seize mortgages of residents who owe more than their properties are worth in a bid to keep them in their homes.
On Wednesday, an investor group filed a federal lawsuit against the northern California city in a bid to stop the plan.
The lawsuit was filed in a northern California court by mortgage bond trustees Wells Fargo and Deutsche Bank on behalf of an investor group that includes Pacific Investment Management Co, or PIMCO, BlackRock Inc and DoubleLine Capital LP.
The use of eminent domain powers to restructure distressed mortgages has been debated by communities for more than a year and has been controversial with Wall Street banks and bond investors from the start.
Alfred Pollard, FHFA's general counsel, said in a memorandum posted on the agency's website on Thursday that the uncertainty surrounding the use of eminent domain raises several issues, including its possible impact on the mortgage market and potential losses that Fannie Mae and Freddie Ma could incur.
"There is a rational basis to conclude that the use of eminent domain by localities to restructure loans for borrowers that are "underwater" on their mortgages presents a clear threat to the safe and sound operations of Fannie Mae, Freddie Mac and the Federal Home Loan Banks as provided in federal law," Pollard wrote.
The FHFA is weighing its legal options in any municipalities that approve loan restructuring programs. The agency is also considering preventing Fannie and Freddie from purchasing loans in those communities using eminent domain as a strategy for restructuring distressed mortgages.
Both Fannie and Freddie, operating under federal conservatorship since they were taken over by the government in 2008 during the financial crisis, are some of the biggest buyers of private home-loan bonds. If eminent domain plans went forward, they would risk losses on bond investments.
Eminent domain is a well-tested power by local government to get a court order to take over a property it deems either blighted or needed for the public good. Historically cities have used the power to force the sale of properties if they obstruct the construction of a project deemed beneficial to the wider community, such as a road or bridge.
(Reporting By Margaret Chadbourn)