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The bailout Wall Street is blocking from Main Street

August 9, 2013: 11:54 AM ET

Banks representing the nation's largest bond investors are suing the city of Richmond, which last week took steps to take over underwater mortgages through eminent domain.

Richmond, California

Richmond, California

FORTUNE -- The working-class California suburb of Richmond is taking matters into its own hands with a bold plan to rescue homeowners from foreclosure where banks and lenders have been slow or unwilling to step in. This is essentially the bailout Main Street never got, and Wall Street is now moving to block it.

On Wednesday, banks representing the nation's largest bond investors sued the city of Richmond, which last week became the first city to adopt a novel plan to take over underwater mortgages through the eminent domain process. Governments typically use eminent domain to forcibly seize land to turn around blighted areas. In Richmond, where roughly half of all homeowners with mortgages are underwater, officials plan to use eminent domain to seize home mortgages from investors at a price potentially below the property's current market value. The city would then reduce the loan balance and refinance those mortgages so that borrowers would end up paying less every month.

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Needless to say, investors aren't thrilled. And the lawsuit against Richmond also isn't surprising, given that the powers of eminent domain have been hotly contested in U.S. courts over the past decade. What's ironic, however, and perhaps even hypocritical, is that Wall Street is fighting the kind of financial rescue it received just five years ago.

Recall that in 2008, amid the height of the financial crisis, Congress created the Troubled Asset Relief Program, a $700 billion package that essentially saved insurer American International Group (AIG), mortgage financiers Freddie Mac and Fannie Mae, as well as auto industry giants General Motors (GM) and Chrysler. However reluctantly Wall Street accepted the help, America's biggest banks received $125 billion of that pile of rescue cash.

All were lucky enough to get bailouts amid the dark days of the financial crisis, unlike the millions of U.S. homeowners who lost their homes to foreclosure. To be sure, the bailouts came with strings attached; companies were required to repay the government, which some have done in full, while others are still doing so.

Richmond could include a similar repayment agreement, which may ease investors' worries about losses. Such an approach, which has the support of Harvard economist Kenneth Rogoff and others, could also soften concerns that if Richmond moves ahead with its plan, and if other communities follow, the risks of lending to those areas could rise and lenders would demand higher down payments and interest rates.

The lawsuit against Richmond was filed by three mortgage-bond trustees, units of Wells Fargo & Co. (WFC), and Deutsche Bank (DB), which, according to the Wall Street Journalwere directed to act by a group of investors, including BlackRock Inc. (BLK), Pacific Investment Management Co., as well as Fannie Mae and Freddie Mac. They argue Richmond's use of eminent domain would benefit only a small group of citizens at a loss for out-of-state investors and therefore violates laws governing interstate commerce. More than that, the lawsuit argues, seizure of loans doesn't benefit the public good.

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Investors may or may not be right, but it's hard to blame cities that have for years urged banks and lenders to give homeowners a break. The lawsuit is clearly a trial balloon for others cities that might follow suit, but it also offers a chance for Wall Street to work a little harder with troubled borrowers.

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About This Author
Nin-Hai Tseng
Nin-Hai Tseng
Writer, Fortune

Nin-Hai Tseng covers economics and finance. Before joining Fortune, Tseng was a reporter at The Orlando Sentinel and a public affairs associate at GE. She holds an MPA from Columbia University and a BS in Journalism from the University of Florida. She lives in New York City.

Email | @ninhaitseng | RSS

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