In my previous post on the the California city of of Richmond’s plan to use eminent domain to condemn underwater mortgages, I noted that the plan is likely to be permissible under the Supreme Court’s decision in Kelo v. City of New London, which says that a taking is for a constitutional “public use,” so long as it might advance some “public purpose” that isn’t “pretextual.” It may well also be permissible under California courts’ lax interpretation of of public use under their state constitution. But I didn’t consider another possible constitutional problem with the Richmond plan: undercompensation [HT: multiple VC readers who have directed my attention to this problem]. When the government condemns private property, the Fifth Amendment requires it to pay “just compensation,” which the Supreme Court has long interpreted as “fair market value.” As Matthew Yglesias sugggests, in many cases the formula used by Richmond would result in compensation below FMV (which is usually defined, roughly, as what the value of the asset in question would be if offered up for sale on the open market).
Here’s the compensation Richmond is offering, as described by the New York Times:
The city is offering to buy the loans at what it considers the fair market value. In a hypothetical example, a home mortgaged for $400,000 is now worth $200,000. The city plans to buy the loan for $160,000, or about 80 percent of the value of the home, a discount that factors in the risk of default.
If the home is worth $200,000 on the open market, as in the hypothetical example above, it is likely that the fair market value of the $400,000 mortgage should be at least that much, or close to it. Even if the owner defaults, the lender can recover that [...]