NEW YORK ( TheStreet) -- A new threat has emerged to the city of Richmond, Calif. plan to seize mortgages through eminent domain. According to a Bloomberg report, the U.S. Department of Housing and Urban Development told lawmakers it is not clear whether the Federal Housing Administration will insure new mortgages in communities, including Richmond, that propose to seize mortgages through eminent domain and write down principal balances. "Pending legal developments and possible further execution of the plans in question, HUD does not know whether any new mortgages which might be created would qualify for insurance by the Federal Housing Administration," Acting Assistant Secretary Elliot Mincberg wrote in an Aug. 12 letter responding to questions from members of Congress, according to the report. Richmond said last month it will partner with "community advisory" firm Mortgage Resolution Partners to buy underwater loans -- mortgages that exceed property values -- from investors for "fair market value" and write down the principal balances of the loans. The city seeks to buy mortgages at a discount to current value of the property, thereby allowing borrowers to get more equity in their homes and making it possible for them to refinance their loans through a government-sponsored program such as the one run by the FHA. But it appears the FHA itself has concerns about the proposal. The use of eminent domain to seize mortgage assets is unprecedented. The plan has been attacked by investors as ill-advised and unconstitutional. Last week, the Federal Housing Finance Agency, regulator of Fannie Mae and Freddie Mac, two of the biggest investors in private-label mortgage-backed securities, issued a strong statement against the proposal, saying it would legally challenge any local or state action that sanctions the use of eminent domain. It will also consider using its authority to "direct the regulated entities to limit, restrict or cease business activities within the jurisdiction of any state or local authority employing eminent domain to restructure mortgage loan contracts; or take such other actions as may be appropriate to respond to market uncertainty or increased costs created by any movement to put in place such programs."
Mortgage bond investors have also threatened legal action against Richmond if it proceeds with its eminent domain plan. Richmond Mayor Gayle McLaughlin has said she intends to proceed with the proposal, despite the legal challenges. "Banks that caused the crisis in the first place need to stop standing in the way of recovery. They should drop this lawsuit and accept our offers -- sell us the loans -- so that we can keep families in their homes," she said in an email statement to TheStreet last week. "The City is willing to pay fair market value for these mortgages, so investors will not suffer losses as a result of this proposal. On the contrary, the investors will generally be better off because they will get fair market value and will no longer have to worry about the risk of default." -- Written by Shanthi Bharatwaj in New York. >Contact by Email. Follow @shavenk