Newark's City Council may consider as early as this week the horrible, absolutely horrible idea of using eminent domain to seize mortgages on homes which are "underwater" in current value. Why is this bad? The one-sentence explanation is this: Housing prices, which depend heavily on bank credit for mortgage financing of purchases, will plunge if and when the government strongly discourages banks from making new loans.
The Newark eminent domain proposal shoves all the risk on banks, yet their return on making a mortgage is simply the return on principal plus periodic interest payments. In case you haven't noticed, mortgage rates recently were at historic lows. While banks have been tripping over each other recently to compete for refinancing business, this should never be confused with an indication that mortgage loans are a high-margin business. They merely want to retain existing cash flow.
When you put aside the carefully-crafted sob story, mortgage eminent domain means that the government can swoop in on banks (or investors) holding mortgages and force them to take a loss on the mortgage by paying them only the current "fair value" of the mortgage. The concept of saying to banks, "Accept our arbitrary determination of 'fair value' or get nothing" is the equivalent of the shotgun robbery. I cannot imagine banks will want to engage in this business for long if eminent domain becomes the order of the day. (And banks routinely drop lines of business which they deem unprofitable, so it would not be unheard of for name banks to stop issuing mortgages.)
Mortgage eminent domain will mean banks and investors -- not the homeowner -- would carry the risk of loss on real estate declining (temporarily) in value. But they don't have the potential upside.
Banks are not charities but are in business to, ahem, make money. The traditional way for banks to do this is by lending. Eminent domain will make loans loss leaders for banks and their natural and foreseeable reaction is for banks to either stop making loans or to jack up interest rates to compensate for the risk of big losses.
If you want to see mortgage rates as high as credit card rates, then support this idea.
If you think banks should just accept losses because, well, you decide that they should pay the price for homeowners overpaying for homes they probably had no business buying, then support this idea.
But don't fool yourself into thinking this will do anything but crash the residential housing market.