They Can't Do That, Can They? Constitutional Limitations On The Seizure Of Underwater Mortgages

This Commentary discusses a proposal, referred to below as "the property seizure program," whereby state and local governments would use their eminent domain power to "condemn" underwater mortgages—that is, mortgages under which the outstanding amount of the debt exceeds the market value of the underlying real property. The property seizure program appears to have generated some momentum over the last few months, collecting the endorsement of both legal scholars and politicians.1 The L.A. Times recently reported that the Board of Supervisors of San Bernardino County unanimously approved a program to use eminent domain to seize mortgages and restructure them for underwater homeowners stuck in their properties.2

Under the property seizure program, private investors would supply state and local governments with capital to provide compensation, at current market value, to banks, lenders, securitization trusts, and other holders of mortgages. Once the mortgages have been condemned, the governments would transfer mortgage rights to the private investors on the condition that they restructure the mortgages to account for the current market value of the underlying real property. The private investors could then retain and service the resulting new mortgages, or sell the new mortgages, presumably at a profit, to another investor.

The property seizure program creates serious concerns for holders of mortgage-backed securities, the vast majority of which are securitization trusts to which those mortgages were transferred. If underwater mortgages were condemned at a steep discount to their face value, these securitization trusts and the holders of mortgage-backed securities issued by such trusts could face significant losses. In addition, uncertainty regarding further governmental action relating to mortgages could result in decreased demand for mortgage-backed securities at a time when investor confidence is only just starting to recover.

This Commentary discusses two potential constitutional impediments to the property seizure program. First, there is a plausible argument that the property seizure program violates the Fifth Amendment's Takings Clause because it accomplishes a taking not for public use. Second, there is a plausible argument that the property seizure program substantially and unjustifiably impairs private contract rights in violation of the Constitution's Contract Clause.


For a taking to be permissible under the Fifth Amendment to the U.S. Constitution, it "must be for a 'public use' and 'just compensation' must be paid to the owner."3 There is a strong argument that the property seizure program constitutes a taking within the meaning of the Takings Clause, and there are plausible arguments that the program fails the "public use" test.

The Program Constitutes a "Taking." Contracts constitute property within the meaning of the Fifth Amendment and are susceptible to a "taking" within the meaning of the Takings Clause.4 To determine whether a contract right has been taken, courts apply either a categorical test or, more commonly, the fact-dependent analysis employed in regulatory takings cases. There are strong arguments that the property seizure program is a taking under either approach.

When the categorical takings analysis is applied in physical takings cases, courts ask whether a physical invasion has occurred, as well as whether the government's regulation has denied all economically productive or beneficial uses of the seized property. While physical invasion is impossible in a contractual...

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