By Guest commentary Friday, July 20th, 2012

By Steve Mintz on July 20, 2012

Eminent domain refers to the power possessed by the state over all property within the state, specifically its power to appropriate property for a public use.

Generally, when a unit of government wants to acquire privately held land, the government attempts to negotiate the purchase of the property for fair value. If the owner does not want to sell, the government files a court action to exercise eminent domain, and serves or publishes notice of the hearing as required by law. In the state of California, the eminent domain process can only be stopped if the proposed taking does not meet the requirements for public purpose or public necessity.

On July 5 it was reported that officials in San Bernardino County, and in the cities of Fontana and Ontario, are considering using eminent domain to seize and restructure underwater mortgages and help struggling homeowners. The idea is to acquire the mortgages of distressed homeowners and restructure them in a way that allows the borrowers to stay in their homes.

As might be expected, banking and housing groups are not on board. They are concerned that forced restructuring through eminent domain could lead to big losses for the investors in these home loans and a loss of confidence in the ability of the cities to repay debt in the future. Seizing mortgages in this way would result in losses for public pension plans, 401(k) plans and individual investors who bought the individual loans as part of a packaged group of securities known as collateralized debt obligations. These securitized assets were at the forefront of the 2008 financial meltdown.

There are two important ethical issues in using the eminent domain process to help one group of homeowners and not others. The first is the problem of moral hazard, whereby the costs of risk-taking are passed along to other parties. The second is basic fairness. Is it fair to help out a group of people who got in over their heads or who no longer have the ability (or desire) to meet their obligations? What about homeowners who did the right thing?

There are many homeowners who are living up to their obligations and making mortgage payments even though their mortgages far exceed the fair market value of their property.

The use of eminent domain rewards irresponsible behavior, even if caused by events out of the control of the benefited party. It sets a bad precedent that the government will be there to help you if economic conditions create challenges that otherwise would be met. It is unfair to others who play by the rules.

The use of eminent domain to refinance underwater mortgages is an ethical slippery slope. Where does it stop? Why not use eminent domain to pay off automobile loans and prevent repossession? Why not restructure student debt to relieve the burden of years of loan repayment?

There is a reason we live in a free market economy. We believe in letting the marketplace resolve issues of supply and demand for housing. We should also learn from the past and acknowledge that various affordable housing programs have not worked to stem the tide of foreclosures and underwater mortgages. The real problem is stagnant economic growth.

The U.S. Constitution states that “No person shall be… deprived of… property, without due process of law; nor shall private property be taken for public use, without just compensation.” The key is to define “for public use.” Public use is generally thought of as having a public benefit, such as seizure to develop infrastructure. The eminent domain action being contemplated by San Bernardino County officials benefits one group of people and might lead to the loss in value of homes for those who have played by the rules.

The free-market solution to the housing dilemma is for banks to work with their customers to restructure debt. We should not expect the banks and investors to sit idly by and watch the government intervene in the process. The eminent domain solution is more akin to socialism than capitalism.

• Steve Mintz is a professor of accounting in the Orfalea College of Business at Cal Poly San Luis Obispo. He blogs about business issues at www.ethicssage.com and www.workplaceethicsadvice.com.