Eminent Domain as a Solution to Housing Woes?

Recently Richmond announced they would be seeking to purchase loans for underwater borrowers at 80% of the market value of the home.  They have sent letters to various lenders, and have partnered with a private equity firm to help finance these purchases, restructure the loans and help their troubled homeowners.  While this sounds like a great idea, the root of the issue is that they are using the threat of seizure via eminent domain if the lenders do not sell these loans for a discount.

While the big banks, and the mortgage industry in general, have been the black sheep of the world since the financial meltdown, using the threat of eminent domain to seize property or mortgages and circumvent the debt on that property is a slippery slope.  While on one hand it may be beneficial to the city and the homeowners in the short term, in the long run it could come back to harm them.  

Loans are made secured by real property.  If the loan is not paid as agreed, the property is the lenders security for the debt.  To undermine that security means lenders cannot feel confident that their money is secure.  If they are not confident that their investment is secure, they are not going to want to lend in those areas where they could potentially lose their investment.  While this may not have a major impact on banks and large institutional loans, the unintended consequences could hit hard money and private money lending much harder.

In a hard money loan, the investor is typically an individual or a group of individuals.  If a city has shown that they are willing to remove the security for loans made on properties in that city, these individual investors are simply not going to be willing to trust their investment in that city.  They will just not write checks for loans in that area.  Large institutions are already taking notice of this, with Freddie Mac saying they may take legal action against Richmond should they use eminent domain to seize the mortgages they are holding.  This will be interesting to watch, especially as it sounds like other cities are considering this option as well.

What do you think?  This is a double edged sword and I would be curious to know what side of the fence people stand on.