Local governments hatch a radical plan to rescue underwater homeowners

House floating on blue water

Some local governments are thinking about seizing homes in order to help underwater homeowners in their community, according to the most recent mortgage industry news reported today by NBCNews.com.

It's a radical but fairly basic idea.

Homeowners are considered to be underwater when they owe more on their mortgage than their home is currently worth.

Using eminent domain, the local government would purchase a homeowner's mortgage at "fair market value" from the bank or investor holding it.

That would force the lender to write off the difference between what the home is currently worth and the balance on the mortgage.

Local officials would then sell the home back to the original owner at the fair market price, allowing them to refinance into a new, cheaper mortgage.

Proponents say that would serve the public good, give a bump to local housing markets and speed economic recovery.

Homeowners would, no doubt, come out on top. Writing down the loan would eliminate mounds of debt for homeowners who would otherwise be stuck in houses or condos they can't sell and can't refinance.

Lenders and investors might benefit as well. They'd be sheltered from the risk of homeowners defaulting on loans.

But why the radical move?

There are still millions of underwater homeowners throughout the nation. A lot of towns have been hit very hard by the housing bust and still haven't recovered, despite help from the public and private sectors.

This is an effort by local governments to step in where the federal government and banking industry failed.

“Federal programs have not been very successful at all, and the private programs have been of limited help,” Gregory Devereaux, administrator for San Bernardino County, Calif., tells NBCNews.com.

San Bernardino County had an unemployment rate of 12.6% in June, and median home prices have fallen to $150,000 from a peak of $370,000.

The Federal Housing Finance Authority, which now supervises Fannie Mae and Freddie Mac, has some big issues with the use of eminent domain to revise mortgage contracts.

So does much of the banking industry, which says the plan will inflict significant losses on lenders and encourage borrowers to think they can just walk away from their obligation to repay their loans. That's the old moral hazard argument against debt foregiveness.

You can find the full NBCNews.com story here: http://economywatch.nbcnews.com/_news/2012/08/16/13301668-governments-mull-radical-solution-to-underwater-mortgages-seize-them?lite.

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