Constitutional Issues Relating to Proposals for Legislation to Impose an Interest Rate Freeze/Reduction on Existing Mortgages

Constitutional Issues Relating to Proposals for Legislation to Impose an Interest Rate Freeze/Reduction on Existing Mortgages

Order Code RL34379
Constitutional Issues Relating to
Proposals for Legislation to Impose an
Interest Rate Freeze/Reduction on
Existing Mortgages
Updated June 11, 2008
David H. Carpenter
Legislative Attorney
American Law Division

Constitutional Issues Relating to
Proposals for Legislation to Impose an
Interest Rate Freeze/Reduction on Existing Mortgages
Summary
The U.S. housing market began to slow in early 2006. This downturn has likely
played a role in the rise of late mortgage payments and foreclosures occurring across
the country over the past year. Many believe that the problem will get worse. The
Joint Economic Committee estimates that around 2 million foreclosures of subprime
mortgages will occur from the beginning of 2007 to the end of 2009.
As a way to slow the decline, some in Congress have suggested passing
legislation that would impose a temporary reduction or freeze in the interest rates of
certain mortgages in order to give mortgage market participants, such as borrowers,
servicers, lenders, and investors, time to refinance, or otherwise adjust the mortgage
terms of borrowers who would not likely be able to keep up with their scheduled
payments. Such a measure would modify existing contracts, which would result in
the loss of property rights of some individuals in the mortgage market. For this
reason, this type of legislation raises some constitutional issues.
This report addresses the possible constitutional implications, most notably
regarding the Fifth Amendment’s Takings Clause, of a temporary interest rate
freeze/reduction as it would relate to investors in mortgage-backed securities
(MBSs), which may aid the crafting of such proposals. This report does not seek to
address a specific legislative proposal; rather, it merely analyzes interest rate
freezes/reductions, generally. MBS investors are chosen for analysis in this report
because they likely would be impacted more by such a measure than other potential
claimants. However, this is not to suggest that other mortgage market participants
could not or would not raise legal challenges because of an interest rate
freeze/reduction.
This report presents an overview of Congress’s authority, pursuant to the
Commerce and Bankruptcy Clauses, to pass laws pertaining to mortgages, and
reviews Contract Clause, Substantive Due Process, and Takings Clause
jurisprudence. After explaining why Contract Clause and Substantive Due Process
claims appear less relevant to the question, this report considers the test a court
would likely use in assessing whether a federal interest rate freeze/reduction would
offend the Takings Clause, while pointing out that courts could apply a different test
in this situation. It also suggests that courts’ analyses could vary according to whether
they focus on the impact that an interest rate freeze/reduction has on whole MBS
trusts or specific investment tranches of those trusts. Where the focus is on tranches
of mortgage-backed securitized trusts, a federal interest rate freeze/reduction, in a
minority of cases, potentially could be considered a “taking” requiring just
compensation for the purpose of the Fifth Amendment. Such a finding would be even
less likely where the focus is on the impact to whole trusts. The number of likely
successful claims and the overall potential liability of the federal government for
those claims (and the litigation costs of unsuccessful claims) is not possible to assess,
at least within the scope of this report.

Contents
Introduction and Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Legislative Authority to Pass an Interest Rate Freeze/Reduction . . . . . . . . . 2
Contract Clause and Substantive Due Process . . . . . . . . . . . . . . . . . . . . . . . . 5
Overview of Takings Clause Jurisprudence . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Four Types of Takings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Physical Taking/Appropriation vs. Regulatory Taking . . . . . . . . . . . . . 7
Historical Precedent: Vinton Branch and Radford . . . . . . . . . . . . . . . . . 8
Application of Penn Central to an Interest Rate Freeze/Reduction . . . . . . . 11
Penn Central Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Economic Impact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Impairment of Investment-Backed Expectations . . . . . . . . . . . . . . . . . 14
Character of the Government Action . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Constitutional Issues Relating to
Proposals for Legislation to Impose an
Interest Rate Freeze/Reduction
on Existing Mortgages
Introduction and Background
The U.S. housing market began to slow in early 2006. This downturn has likely
played a role in the rise of late mortgage payments and foreclosures occurring across
the country over the past year.1 Many believe that the problem will get worse. The
Joint Economic Committee estimates that around 2 million foreclosures of subprime
mortgages will occur from the beginning of 2007 to the end of 2009.2
As a way to slow the decline, some in Congress have suggested passing
legislation that would impose a temporary reduction or freeze in the interest rates of
certain mortgages in order to give mortgage market participants, such as borrowers,
servicers, lenders, and investors, time to refinance, or otherwise adjust the mortgage
terms of borrowers who would not likely be able to keep up with their scheduled
payments. Such a measure would modify existing contracts, which would result in
the loss of property rights of some individuals in the mortgage market. For this
reason, this type of legislation raises some constitutional issues.
This report addresses the possible constitutional implications, most notably
regarding the Fifth Amendment’s Takings Clause, of a temporary interest rate
freeze/reduction as it would relate to investors in mortgage-backed securities
(MBSs), which may aid the crafting of such proposals. This report does not seek to
address a specific legislative proposal; rather, it merely analyzes interest rate
freezes/reductions, generally. MBS investors are chosen for analysis in this report
because they likely would be impacted more by such a measure than other potential
claimants. However, this is not to suggest that other mortgage market participants
1 See CRS Report RL33930, Subprime Mortgages: Primer on Current Lending and
Foreclosure Issues, by Edward Vincent Murphy, and CRS Report RS22511, Preliminary
Observations on the Impact of the Bankruptcy Abuse Prevention and Consumer Protection
Act of 2005 (P.L. 109-8), by Brian Cashell, Mark Jickling, and Heather D. Negley. See also,
Joint Economic Committee, “Mortgage Woes Weigh on Financial Markets,” September 11,
2007, available at
[http://www.house.gov/jec/Economic%20Update/RED%20September%2011.pdf].
2 Joint Economic Committee, “The Subprime Lending Crisis: The Economic Impact on
Wealth, Property Values and Tax Revenues, and How We Got Here,” October 2007,
available at [http://jec.senate.gov/Documents/Reports/10.25.07OctoberSubprimeReport.
pdf].

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could not or would not raise legal challenges because of an interest rate
freeze/reduction.
This report presents an overview of Congress’s authority, pursuant to the
Commerce and Bankruptcy Clauses, to pass laws pertaining to mortgages, and
reviews Contract Clause, Substantive Due Process, and Takings Clause
jurisprudence. After explaining why Contract Clause and Substantive Due Process
claims appear less relevant to the question, this report considers the test a court
would likely use in assessing whether a federal interest rate freeze/reduction would
offend the Takings Clause, while pointing out that courts could apply a different test
in this situation. It also suggests that courts’ analyses could vary according to whether
they focus on the impact that an interest rate freeze/reduction has on whole MBS
trusts or specific investment tranches of those trusts. Where the focus is on tranches
of mortgage-backed securitized trusts, a federal interest rate freeze/reduction, in a
minority of cases, potentially could be considered a “taking” requiring just
compensation for the purpose of the Fifth Amendment. Such a finding would be even
less likely where the focus is on the impact to whole trusts. The number of likely
successful claims and the overall potential liability of the federal government for
those claims (and the litigation costs of unsuccessful claims) is not possible to assess,
at least within the scope of this report.3
Legislative Authority to Pass an
Interest Rate Freeze/Reduction
The constitutionality of legislation that imposes an interest rate freeze/reduction
on mortgages may be affected by the context in which it is raised, and by extension
the authority by which Congress passes such a statute. For example, a piece of
legislation providing general, regulatory reform of the housing finance market is
more likely to fall under Congress’s Commerce Clause authority. Whereas,
legislation that is more tailored to asset allocation between a debtor and her creditors
is more likely to be considered an extension of Congress’s Bankruptcy Clause
authority. The parameters of Congress’s authority pursuant to these two clauses are
addressed in turn.
The Constitution grants Congress vast authority to enact laws involving
interstate commerce. Article I, § 8, clause 3 of the U.S. Constitution states:
“Congress shall have the Power To ... regulate Commerce with foreign Nations and
among the several States ....” Commerce “among the several States” must, by
“necessity” include commerce “between the states.”4 The power extends beyond the
3 Quantifying the potential liability would require details of all, or a representative
subsection of, the tranches of mortgage-backed securitized trusts. Because investors of
these securities are largely unregulated, this information may not exist at all. If it does exist,
the information is likely proprietary.
4 Gibbons v. Ogden, 22 U.S. (9 Wheat.) 1, 196 (1824); Stoutenburgh v. Hennick, 129 U.S.
141 (1889); Atlantic Cleaners & Dyers v. United States, 286 U.S. 427 (1932); In re Bryant,
4 Fed. Cas. 514 (No. 2067) (D. Oreg. 1865); Hanley v. Kansas City Southern Ry. Co., 187
U.S. 617 (1903); Western Union Tel. Co. v. Speight, 254 U.S. 17 (1920).

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borders of individual states because it would not be possible for Congress to regulate
commerce that takes place exclusively on states’ borders.
While there was a time when the courts interpreted the Commerce Clause more
restrictively, the melding of 50 different economies into a single national economy
has played a significant role in its expansion.5 Indeed, the U.S. Supreme Court has
only twice since the 1930s invalidated federal legislation because Congress had
exceeded its Commerce Clause power. In both of those cases, the Court held that the
statute being challenged was not economic in nature, and therefore, did not have a
substantial effect on interstate commerce.6
The Court has said that statutes that regulate one of three categories of
commercial activities are within congressional authority:
First, Congress may regulate the use of the channels of interstate commerce.
Second, Congress is empowered to regulate and protect the instrumentalities of
interstate commerce, or persons or things in interstate commerce, even though
the threat may come only from intrastate activities. Finally, Congress’ commerce
authority includes the power to regulate those activities having a substantial
relation to interstate commerce, i.e., those activities that substantially affect
interstate commerce.7
The last of these categories allows courts to examine the cumulative effect of a
commercial activity on the economy as a whole. This is the category within which
an interest rate freeze/reduction likely would fall.
A federally mandated interest rate freeze/reduction designed to reduce the
effects of a slowing national housing market seems to pertain to financial transactions
that, “viewed in the aggregate, substantially affect interstate commerce.”8 Even if
viewed as entirely intrastate, such a law also would likely be considered “part of a
larger regulation of economic activity, in which the regulatory scheme could be
undercut unless the intrastate activity were regulated,” due to the fact that the
5 New York v. United States, 505 U.S. 144, 158 (1992) (“The volume of interstate
commerce and the range of commonly accepted objects of government regulation have ...
expanded considerably in the last 200 years, and the regulatory authority of Congress has
expanded along with them. As interstate commerce has become ubiquitous, activities once
considered purely local have come to have effects on the national economy, and have
accordingly come within the scope of Congress’ commerce power.”).
6 United States v. Morrison, 529 U.S. 598, 617 (2000); United States v. Lopez, 514 U.S.
549, 561 (1995) (“[the] criminal statute [] by its own terms has nothing to do with
‘commerce’ or any sort of economic enterprise ... [and] is not an essential part of a larger
regulation of economic activity, in which the regulatory scheme could be undercut unless
the intrastate activity were regulated. It cannot, therefore, be sustained under our cases
upholding regulations of activities that arise out of or are connected with a commercial
transaction, which viewed in the aggregate, substantially affect interstate commerce.”).
7 Id. at 558-59 (citations omitted).
8 Id. at 561.

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secondary market links local real property into a national market.9 Although not
beyond debate, it seems likely that a court would find a statute imposing an interest
rate freeze/reduction to be within Congress’s constitutional authority.
Congress also has broad authority, concurrent with its authority under the
Commerce Clause, to enact “uniform laws on the subject of Bankruptcies.”10 The
Supreme Court has approved of Congress’s use of this authority to impair contracts
and even to avoid liens.11 In fact, the modification of contract rights is one of the
main purposes of bankruptcy. For these reasons, if a court finds such legislation to
be a valid extension of Congress’s bankruptcy power, then that court may provide
Congress greater deference under a takings analysis than it would for legislation
passed pursuant to the Commerce Clause.12
Whether or not an interest rate freeze/reduction would fall within the
Bankruptcy Clause likely would depend on the scope and nature of a specific
proposal, as well as Congress’s intent for its passage. The more limited the
application of such legislation is to debtors who meet the qualifications to file for
bankruptcy, probably the more likely a court would find the legislation to be a valid
extension of bankruptcy power. Such a determination also may be contingent upon
9 Quoting, id. at 549.
10 U.S. CONST art. I, § 8, cl. 4. One important difference between the Commerce Clause and
the Bankruptcy Clause, is that laws passed under by the Bankruptcy Clause must be
uniform. Railway Labor Executives’ Assn. v. Gibbons, 455 U.S. 457, 465 (1981). The Court
in Gibbons held that a bankruptcy statute that applied to only one debtor was not uniform.
Id. at 471. The court also explained the difficulty in:
[d]istinguishing a congressional exercise of power under the Commerce Clause
from an exercise under the Bankruptcy clause ... Although we have noted that the
subject of bankruptcies is incapable of final definition, we have previously
defined “bankruptcy” as the subject of the relations between an insolvent or
nonpaying or fraudulent debtor and his creditors, extending to his and their relief.
Congress’ power under the Bankruptcy Clause contemplates an adjustment of a
failing debtor’s obligations This power extends to all cases where the law causes
to be distributed, the property of the debtors among his creditors. It includes the
power to discharge the debtor from his contracts and legal liabilities, as well as
to distribute this property. The grant to Congress involves the power to impair
the obligation of contracts, and this the States were forbidden to do.
Id. at 466 (internal citations and quotations omitted).
11 Hanover Nat’l Bank v. Moyses, 186 U.S. 181 (1938); In re Klein, 42 U.S. (1 How) 277
(1843).
12 This deference probably would increase the foreseeability of a statutorily imposed interest
rate freeze/reduction, which is important to an analysis under the “impairment of
investment-backed expectations” prong of the takings test that a court is likely to apply to
the legislation in question. For more information on this prong, see the “Impairment of
Investment-Backed Expectations” subsection of the “Application of Penn Central to an
Interest Rate Freeze/Reduction” section of this report.

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a court’s interpretation of the breadth of Congress’s power under the Bankruptcy
Clause, which cannot be predicted.13
Regardless of which of these two sources of authority are applied, the legislative
proposal in question would still be subject to certain constitutional protections such
as those provided by the Fifth Amendment’s Due Process and Takings Clauses.
Contract Clause and Substantive Due Process
Before discussing the relevant portions of the Fifth Amendment, some common
misconceptions regarding the Contract Clause should be addressed. Article I, § 10,
clause 1 of the U.S. Constitution states: “No State shall ... pass any ... Law impairing
the Obligation of Contracts....” This clause prohibits states from passing legislation
that makes certain changes to the terms of existing contracts.14 The language of the
Contract Clause is expressly limited to the states. Additionally, the Court has held
that the principles of the Contract Clause are not incorporated against the federal
government by the Fifth Amendment’s Due Process Cause.15 The Court explained:
We have never held ... that the principles embodied in the Fifth Amendment’s
Due Process Clause are coextensive with provisions existing against state
impairments of pre-existing contracts.... [Rather,] we have contrasted the
limitations imposed on States by the Contract Clause with the less searching
standards imposed on economic legislation by the Due Process Clauses.16
Therefore, the Contract Clause does not apply to federal legislation.
Federal legislation, on the other hand, is subject to the protections of substantive
due process. Substantive due process “prevents government power from being used
for purposes of oppression, or abuse of government power that shocks the
conscience, or action that is legally irrational in that it is not sufficiently keyed to any
13 Measures, such as H.R. 3609 (the Emergency Home Ownership and Mortgage Equity
Protection Act, as it was ordered to be reported favorably by the House Judiciary
Committee) likely would be a valid extension of Congress’s authority to pass uniform laws
on bankruptcies because those bills seek to amend how certain debts secured by the debtor’s
primary residence are dealt with in a Chapter 13 bankruptcy reorganization plan. It is less
clear if a piece of legislation that places an interest rate freeze/reduction on all mortgages
originated nationwide or a certain group of mortgages that are not in default or delinquent
could be passed pursuant to Congress’s bankruptcy authority. For more information on H.R.
3609 and similar bills, see CRS Report RL34301, The Primary Residence Exception:
Legislative Proposals in the 110th Congress to Amend Section 1322(b)(2) of the Bankruptcy
Code, by David H. Carpenter.
14 For an example of how the Supreme Court has analyzed state impairment of contracts, see
Home Building and Loan Assoc. v. Blaisdell, 290 U.S. 398 (1934) (upholding a state statute
that imposed a foreclosure moratorium on certain properties).
15 PBGC v. R.A. Gray & Co., 467 U.S. 717, 733 (1984). Accord, United States v. Winstar
Corp., 518 U.S. 839, 875-76 (1996).
16 PBGC, 467 U.S. at 733.

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legitimate government purpose.”17 An interest rate freeze/reduction that is
implemented for the purpose of providing lenders and servicers time to initiate loan
modifications and loss mitigation in order to strengthen an ailing market would not
likely be violative of substantive due process in light of the vast deference courts
provide the government in the context of economic regulation.18 Consequently, this
report focuses on takings law analysis.19
Overview of Takings Clause Jurisprudence

The Fifth Amendment concludes with the words “nor shall private property be
taken for public use, without just compensation.” The Takings Clause requires
striking a balance between the government’s public goals and the burdens suffered
by private property owners as the government takes measures to meet its goals. The
courts have recognized relatively few governmental infringements of private citizens’
property as constitutional “takings” where no outright seizure or permanent physical
occupation of the property occurs. The infringement must rise to a certain severity
or be of a particular kind before courts will say a “taking” has occurred. Only then
must the government provide “just compensation” to the property owner.20 The
courts have developed an array of tests, rules, and factors to determine what does and
does not constitute a “taking.”
Four Types of Takings. The proper test to apply depends on the type of
governmental action involved. There are four broad categories of takings recognized
by the Supreme Court.21 Two of these tests are clearly not applicable to an interest
rate freeze/reduction. One is a land-use exaction taking, such as a mandatory set aside
for a certain portion of a new housing development to be green space.22 The other is
a type of regulatory taking, as described in Lucas v. South Carolina Coastal
Council,23 where the government “deprive[s] an owner of all economically beneficial
use of her property.” This type of infringement is considered a per se taking and is
17 Torromeo v. Town of Fremont, N.H., 438 F.3d 113, 118 (1st Cir. 2006). Prior to 2005,
there was a great deal of confusion among courts in how to properly delineate between
takings law and substantive due process analysis, which was partially alleviated by the
Supreme Court’s 2005 Lingle v. Chevron U.S.A. Inc. decision. 544 U.S. 528 (2005). See,
e.g., Agins v. City of Tiburon, 447 U.S. 255 (1980); Kavanau v. Santa Monica Rent Control
Bd., 941 P.2d 851 (Cal. 1997). While some confusion remains, the Court has clarified that
substantive due process and takings law address unique concerns.
18 See, e.g., Eastern Enterprises v. Apfel, 524 U.S. 498 (1998).
19 It also is possible for one to claim an Equal Protection Clause violation, especially if the
claimant believes that she was treated unequally. See, e.g., Village of Willowbrook v. Olech,
528 U.S. 562 (2000). An Equal Protection Clause violation is not likely to result from an
interest rate freeze/reduction that is not limited to members of a protected class, such as race
or ethnicity.
20 Mortgages and the contract rights to mortgage-backed securities investments are private
property for the purpose of Fifth Amendment protections.
21 Lingle, 544 U.S. at 538.
22 Id.
23 506 U.S. 1003 (1992).

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commonly referred to as a Lucas “total taking.”24 Most courts agree that Lucas total
takings only apply to land, not personal property such as contract rights.25 An interest
rate freeze/reduction could be assessed pursuant to one of the other two tests. One is
a “physical taking” or “appropriation” where the “government requires an owner to
suffer permanent physical invasion of her property.”26 The final test is for all
regulatory takings other than total takings, which are analyzed pursuant to the test
originally set out in Penn Central Transp. Co. v. City of New York.27
Physical Taking/Appropriation vs. Regulatory Taking. Plaintiffs would
likely argue that legislation imposing an interest rate freeze/reduction resulted in a
“permanent physical occupation” of their property, as these are considered per se
takings, warranting just compensation. While on the contrary, the government would
likely argue that this type of legislation should be analyzed under Penn Central,
where the government usually wins. One takings law commentator explains:
The Court’s decisions using per se physical taking analysis ... typically involve
physical invasions in the literal sense — invasions by aircraft, flood waters, the
boating public, government personnel, cable boxes, and mobile-home-park
tenants. But in some factual contexts ... physical and regulatory takings have
proved difficult to keep separate.
The tendency to blur the two is enhanced by the powerful incentives plaintiffs
have to urge a physical, versus regulatory, theory in a case. First, there is the
lesser showing needed for plaintiff to win on a permanent physical occupation
claim.... Second, ... [is] the extremely narrow range of application for the ... total
taking test, leaving the physical occupation rule as the only per se rule left to
plaintiff in many cases.... [One example of where this line is blurred is where a]
government program causes no physical invasion, but affects the property owner
in a way more or less akin to an appropriation. Here, the takings analysis may go
either way — regulatory or physical. The issue played out at length in cases
involving state demands that small interest amounts on lawyers’ trust accounts
be paid to a state-run program funding legal services for the poor, and was
ultimately resolved as a physical-type taking.28
24 Lingle, 544 U.S. at 538.
25 See, e.g., Hawkeye Commodity Promotions, Inc. v. Vilsack, 486 F.3d 430, 441 (8th Cir.
2007) (“it appears that Lucas[‘ total takings test] protects real property only”); Unity Real
Estate v. Hudson, 178 F.3d 649, 674 (3rd Cir. 1999) (“To date, the categorical approach has
only been used in real property cases such as Lucas v. South Carolina ....”). However, at
least one Federal Circuit case has applied total takings analysis to personal property, though
it did not find a taking had occurred. Maritrans v. United States, 342 F.3d 1344 (Fed. Cir.
2003).
26 Lingle, 544 U.S. at 538.
27 438 U.S. 104 (1978) (the Court found no taking where New York City, pursuant to a
historic preservation ordinance, prevented a property owner from developing the air rights
over a historic landmark). See also, Lingle 544 U.S. at 538-39.
28 Robert Meltz, Takings Law Today: A Primer for the Perplexed, 34 Ecology L.Q. 307,
364-65 (2007).

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It is possible that a court would consider an interest rate freeze/reduction a
physical taking or an appropriation of an MBS investor’s rights to the income stream
lost due to the legislation, and therefore, a per se taking. This argument would likely
be given some credence because the focus of the proposals being considered for
legislation, interest payments, is such a central element of a mortgage. What might
be fundamental to a court’s inquiry is whether the interest rate modification would
have been allowed under the Pooling and Servicing Agreement (PSA). PSAs are the
contracts for mortgage-backed securitized trusts that govern the legal relationship
between MBS trustees, MBS investors, and servicers of the mortgages comprising
these trusts. While not all PSAs are exactly alike, one relevant feature of typical
agreements is the scope of the permission of servicers to perform loss mitigation and
loan modification for borrowers. In instances where a mortgage would qualify for an
interest rate freeze/reduction under federal legislation, but where the borrower would
not have qualified for a modification under the PSA, finding a physical taking would
be more likely. The more tailored the scope of any legislation to the situations in
which servicers have authority to adjust mortgage interest rates pursuant to governing
PSAs, the less likely a court would find a physical taking.29
A more probable scenario, especially in light of the fact that the income lost as
a result of an interest rate freeze/reduction would not directly accrue to the
government, as was the case with the interest from the lawyer’s trust accounts, is that
a court would consider such a statute as a possible regulatory taking, to be analyzed
pursuant to Penn Central.
Historical Precedent: Vinton Branch and Radford.
While it seems most likely in light of recent jurisprudence that courts would
address a takings claim raised in response to an interest rate freeze/reduction under
the parameters set out in Penn Central, it is possible that a court might be influenced
by the similar fact patterns of two Supreme Court cases from the 1930s, Wright v.
Vinton Branch30 and Louisville Joint Stock Land Bank v. Radford.31
Congress enacted the Frazier-Lemke Act of 1934, which amended the
Bankruptcy Act to provide farmers a five-year mortgage foreclosure moratorium,
allow farmers to keep possession of real property for a reasonable rent, and allow
them to pay a judicially appraised purchase value at the end of the five years for the
purpose of preventing widespread farm foreclosures.32 The Supreme Court in
29 For more information regarding the securitization process and provisions of typical PSAs,
see CRS Report RS22722, Securitization and Federal Regulation of Mortgages for Safety
and Soundness, by Edward Vincent Murphy, and CRS Report RL34372, The HOPE NOW
Alliance/American Securitization Forum (ASF) Plan to Freeze Certain Mortgage Interest
Rates, by David H. Carpenter and Edward Vincent Murphy.
30 300 U.S. 440 (1937).
31 295 U.S. 555 (1934).
32 See id. at 598-99.

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Radford held the Frazier-Lemke Act to be in violation of the Fifth Amendment, and
thus unconstitutional.33 The Court stated:
The decision in the Radford case did not question the power of Congress to offer
to distressed farmers the aid of a means of rehabilitation under the bankruptcy
clause [sic]. The original Frazier-Lemke Act was there held invalid solely on the
ground that the bankruptcy power of Congress, like its other great powers, is
subject to the Fifth Amendment; and that, as applied to the mortgages given
before its enactment, the statute violated that Amendment, since it effected a
substantial impairment of the mortgagee’s security. The opinion enumerates five
important substantive rights in specific property which had been taken. It was not
held that the deprivation of any one of these rights would have rendered the Act
invalid, but that the effect of the statute in its entirety was to deprive the
mortgagee of his property without due process of law. The rights enumerated
were:
1. The right to retain the lien until the indebtedness thereby secured is paid.
2. The right to realize upon the security by a judicial public sale.
3. The right to determine when such sale shall be held, subject only to the
discretion of the court.
4. The right to protect its interest in the property by bidding at such sale
whenever held, and thus to assure having the mortgaged property devoted
primarily to the satisfaction of the debt, either through receipt of the proceeds of
a fair competitive sale or by taking the property itself.
5. The right to control meanwhile the property during the period of default,
subject only to the discretion of the court, and to have the rents and profits
collected by a receiver for the satisfaction of the debt.34
However, the Radford decision was called into question just three years later by
the Vinton Branch Court, in which a slightly modified version of the Frazier-Lemke
Act, which was found to no longer deprive three of the five above-listed substantive
rights, was deemed in accordance with the Fifth Amendment.35 The Court explained:
The power here exerted by Congress is the broad power “To establish ... uniform
Laws on the subject of Bankruptcies throughout the United States.” The question
which the objections raise is not whether the Act does more than modify
remedial rights. It is whether the legislation modifies the secured creditor’s
rights, remedial or substantive, to such an extent as to deny the due process of
law guaranteed by the Fifth Amendment.... For the reasons stated, we are of
opinion that the provisions of subsection (s) [of the Frazier-Lemke Act] make no
unreasonable modification of the mortgagee’s rights; and hence are valid.36
33 Id. at 589-90.
34 Vinton Branch, 300 U.S. at 456-57 (internal citations ommited).
35 Id. at 470.
36 Id.

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While it is possible that a current court would look to Vinton Branch as
authoritative on the question of a takings claim raised as a result of a federal interest
rate freeze/reduction because that opinion addresses similar facts as those assessed
in this report and because it has not been expressly overruled, it seems more likely
that a court would analyze such a takings claim under the test outlined in Penn
Central.
First of all, the Vinton Branch decision came down more than 40 years prior to
Penn Central. In those 40 years and the subsequent 30, much has changed in takings
jurisprudence.37 Most notably, Vinton Branch was delivered at a time in which the
courts did not delineate between the Fifth Amendment’s Due Process Clause and the
Fifth Amendment’s Takings Clause. This point is emphasized by the varying
language used in the Radford and Vinton Branch cases. The Radford decision states
that the ultimate question to be addressed is “whether the Frazier-Lemke Act as
applied has taken from the Bank without compensation, and given to Radford, rights
in specific property which are of substantial value.”38 Whereas the Vinton Branch
opinion characterizes the ultimate question as whether the act “modifies the secured
creditor’s rights ... to such an extent as to deny the due process of law guaranteed by
the Fifth Amendment.”39 It was not until the 2005 Supreme Court decision, Lingle
v. Chevron U.S.A. Inc., that the High Court made it clear that the tests to be applied
under takings claims are distinct from those analyzing potential due process
violations.40 The Lingle Court confirmed that:
a plaintiff seeking to challenge a government regulation as an uncompensated
taking of private property may proceed under one of the other theories discussed
37 As one court explained, “whether or not Louisville Joint Stock Land Bank v. Radford has
any current value as precedent is subject to reasonable doubt. Times have changed, and a
review of its progeny discloses a constant and steady erosion of its vitality.” In re
Pommerer, 10 B.R. 935, 945 (Bankr. Ct. D. Minn. 1981). However, neither case has been
formally overruled, and some lower courts have cited both within the last 20 years.
38 Radford, 555 U.S. at 601 (emphasis added).
39 Vinton Branch, 300 U.S. at 470 (emphasis added).
40 Lingle, 544 U.S. at 542-43 (“The ‘substantially advances’ formula suggests a means-ends
test: It asks, in essence, whether a regulation of private property is effective in achieving
some legitimate public purpose. An inquiry of this nature has some logic in the context of
a due process challenge, for a regulation that fails to serve any legitimate governmental
objective may be so arbitrary or irrational that it runs afoul of the Due Process Clause. But
such a test is not a valid method of discerning whether private property has been ‘taken’ for
purposes of the Fifth Amendment.... A test that tells us nothing about the actual burden
imposed on property rights, or how that burden is allocated, cannot tell us when justice
might require that the burden be spread among taxpayers through the payment of
compensation. The owner of a property subject to a regulation that effectively serves a
legitimate state interest may be just as singled out and just as burdened as the owner of a
property subject to an ineffective regulation. It would make little sense to say that the second
owner has suffered a taking while the first has not. Likewise, an ineffective regulation may
not significantly burden property rights at all, and it may distribute any burden broadly and
evenly among property owners. The notion that such a regulation nevertheless ‘takes’
private property for public use merely by virtue of its ineffectiveness or foolishness is
untenable.” (emphasis original) (internal citations omitted)).

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above — by alleging a “physical” taking, a Lucas-type “total regulatory taking,”
a Penn Central taking, or a land-use exaction violating the standards set forth in
Nollan and Dolan.41
While Penn Central is likely to govern, this does not mean that a piece of
legislation crafted to meet the test set out in Vinton Branch could not also pass the
three balancing factors of Penn Central. These three factors are analyzed in great
detail below, but as an example, an interest rate freeze/reduction statute that lasts for
a relatively short period of time and that requires borrowers to make reasonable
monthly payments in order to qualify for the interest rate adjustment will reduce the
economic impact of the legislation on MBSs (mortgage-backed securities) investors’
property rights, thus diminishing the strength of their takings arguments.
Application of Penn Central to an
Interest Rate Freeze/Reduction
Penn Central Overview. Before beginning any analysis, it should be noted
that Takings Clause jurisprudence is a highly amorphous and an ever-evolving area
of the law. Additionally, the question of whether a statutorily imposed interest rate
freeze/reduction violated the Takings Clause has never been addressed directly by a
court. The Penn Central test is, as the Supreme Court has stated, an “essentially ad
hoc and factual inquir[y].”42 Finally, the mortgage-backed securities industry is a
highly complex, yet largely unregulated industry, which makes garnering specific
information about the tranches of each mortgage-backed securitized trust very
difficult. All of these factors make analysis of how a court might rule on a takings
issue quite difficult even where all facts are known. With those caveats in mind, the
following analysis informs on how courts have assessed each of the three Penn
Central factors and highlights certain contexts or facts that courts emphasize as
triggering Takings Clause protection that may be implicated by such legislation.
Legislation targeting private contracts usually survives takings attacks under
Penn Central analysis.43 However, this does not mean that a court could not find a
takings under certain circumstances, nor does it mean that secondary market investors
would not bring suits claiming takings had occurred, which comes with its own costs
41 Id. at 548 (citing Nollan v. California Coastal Comm’n, 483 U.S. 825 (1997), and Dolan
v. City of Tigard, 512 U.S. 374 (1994)).
42 Penn Central, 438 U.S. at 124.
43 It should be noted that the Supreme Court has indicated that government actions that are
implemented for a public benefit and only incidentally interfere with the performance of
private contracts constitute only a frustration, not a taking, of contract rights. Omnia
Commercial Co. v. United States, 261 U.S. 502 (1923). The legislative issue this report is
addressing, on the other hand, would directly target private mortgage contracts, as opposed
to incidentally interfering with the contracts. When legislation specifically targets an
existing contract or a class of contracts, the courts have found that Omnia does not apply,
and instead have applied Penn Central’s balancing test. See, Cienega Gardens v. United
States, 331 F.3d. 1319, 1335 (Fed. Cir. 2003) (“Omnia ... refers to legislation targeted at
some public benefit, which incidentally affects contract rights, not ... legislation aimed at
the contract rights themselves in order to nullify them.”).

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to the government. It seems plausible, as discussed in greater detail below, that a
statute imposing an interest rate freeze/reduction could have a significant enough
effect on a minority of MBS tranches as to rise to the level of a taking.
The Penn Central test consists of three factors that are designed to determine
whether the government regulatory action has resulted in the deprivation of a
property right sufficient to violate the Takings Clause. The three factors are: (1) the
economic impact of the government action; (2) the “extent to which the regulation
has interfered with distinct investment-backed expectations”; and (3) the character
of the government action.44 The Supreme Court has shed little light on the content of
these three factors or on how to balance them, and each factor raises “vexing
subsidiary questions.”45
Economic Impact. The Penn Central inquiry “turns in large part, albeit not
exclusively” on the economic impact factor.46 In assessing the economic impact,
courts evaluate the proportion of the loss caused by the regulation to the “parcel as
a whole.”47 This means that, in weighing the economic impact, the courts look at
entire property, rather than exclusively at the portion of the real property affected by
the legislation in isolation. The Supreme Court explained it this way:
a claimant’s parcel of property could not first be divided into what was taken and
what was left for the purpose of demonstrating the taking of the former to be
complete and hence compensable. To the extent that any portion of property is
taken, that portion is always taken in its entirety; the relevant question, however,
is whether the property taken is all, or only a portion of, the parcel in question.48
The “parcel as a whole” concept has three different dimensions: physical/spatial,
functional, and temporal. In the context of a takings claim raised by investors of
MBSs, compelling arguments could be made to define the physical “parcel” as either
the tranches of each trust or the securitized trust as a whole. This report focuses on
the tranches as the physical parcel interpretation because such a definition would
result in the strongest arguments for a taking, thus emphasizing potential legal issues
that interest rate freeze/reduction legislation may raise, which is the purpose of this
report. The other option would make a successful takings claim less likely because
the impact of such an interest rate change would be spread out over the hundreds or
thousands of other mortgages within each trust.
44 Penn Central, 438 U.S. at 124-28; Pennsylvania Coal Co. v. Mahon, 260 U.S. 393, 415
(1922); Nollan v. California Coastal Comm’n, 483 U.S. 825, 834 (1985).
45 Lingle, 544 U.S. at 539.
46 Lingle, 544 U.S. at 540.
47 The parcel as a whole concept was originally established, as was most of Takings Clause
jurisprudence, for land-use takings claims. The courts have extended the parcel as a whole
concept to contexts other than land-use, such as employee pension plans, Concrete Pipe &
Products, Inc. v. Construction Laborers Pension Trust, 508 U.S. 602, 644 (1993), and
mortgage restrictions on low-income housing projects, Cienega Gardens v. United States,
503 F.3d 1266 (Fed. Cir. 2007).
48 Concrete Pipe, 508 U.S. at 644.

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To address the functional dimension, courts would look to how the
governmental interference affects the entire “bundle of rights,” as opposed to a single
right within the bundle.49 In the MBS context, an investor’s bundle of rights would
include everything provided in the governing PSA, including rights to a certain
income stream and contract claims for violations of the PSA. The temporal
dimension requires an assessment of the physical parcel for the entire time period
during which the plaintiff has an interest in that property.50 For example, if an
investor owned a tranche that consisted of the 12-month income stream, from both
principal and interest payments, of a group of mortgages, and a six-month interest
rate freeze was imposed in the middle of that period, the court would analyze the
economic impact to that investor in relation to the whole 12 months, not just the six
months of the freeze (temporal dimension) and in relation to the income from both
principal and interest, not just the interest payments changed by the freeze
(functional).
Courts vary in how they determine the economic loss caused by regulations.
Most courts look to either the property’s “diminution in value” or “diminution in
return” caused by the regulation.51 Under both, courts are in agreement that the loss
must be significant. The Supreme Court has in past cases found diminutions in
property upwards of 75% to not, by themselves, be enough to be considered a
“taking.”52 Determining the severity of the lost value or return caused by the
legislation in question would be an entirely fact-specific inquiry.
The complexity of the secondary market coupled with its lack of governmental
oversight, hamper the ability to fully assess how many, and to what extent, tranches
of mortgage-backed securitized trusts would be affected by a statutorily imposed
interest rate freeze/reduction of certain mortgages. When mortgages are sold in the
secondary market, they are often lumped in trust and then separated into tranches on
the basis of certain common characteristics. Mortgages can be left intact or they can
be diced into pieces. For example, a tranche could consist entirely of 30-year, fixed,
prime rate mortgages that do not include prepayment penalties. Or, a tranche could
consist of only the income stream from the interest payments of subprime mortgages
with two-year ARMs. Or, a tranche could be comprised of 25% of the first group and
75% of the second group. There are virtually no limits to what can comprise a
tranche.
It is conceivable that there are or would be tranches that represent, in whole or
in part, the income from the planned interest rate adjustment that is eliminated or
49 Andrus v. Allard, 444 U.S. 51, 66 (1979), cited in Tahoe-Sierra Pres. Council, Inc. v.
Tahoe Reg’l Planning Agency, 535 U.S. 302, 327 (2002).
50 Tahoe-Sierra, 535 U.S. at 331-32.
51 Rose Acre Farm, Inc. v. United States, 75 Fed. Cl. 527, 532 (2007). Other courts have
looked to whether only a small number of many contractual rights are affected by the
regulation. See, McAndrews v. Fleet Bank of Massachusetts, 989 F.2d 13, 18-19 (1st Cir.
1993). However, this type of analysis would not fit well in the context of a takings claim
raised by an investor of MBSs.
52 See, Concrete Pipe, 508 U.S. at 645.

CRS-14
significantly reduced by a federal interest rate freeze or reduction. In these cases,
legislation could result in up to a 100% diminution in value or diminution in return
of the tranches. Where a tranche loses its entire value due to federal legislation, a
taking likely has occurred. It is unclear where a court would draw the line in cases
where some, but less than a 100% loss results, though almost certainly, the
percentage would be quite high. For intermediate percentages, the other two prongs
of the Penn Central test likely are to be of importance.
Impairment of Investment-Backed Expectations. When examining
whether congressional impairment of private contracts interferes with investment-
backed expectations, courts typically have focused on whether it was reasonable for
the harmed party to assume that the impairment would not occur.53 “The critical
question is whether extension of existing law could be foreseen as reasonably
possible.”54 To do so, courts generally look to the type and level of regulation the
claimant faced prior to implementation of the regulation in question. If, for instance,
the subject of the regulation was part of a “heavily regulated field” prior to the
additional legislative impairment, then additional regulation is more likely to have
been “foreseeable” to the harmed party. The courts have concluded, for example, that
national banks55 and employee pension plans56 are in heavily regulated fields.57
However, low-income housing is not.58
The proposals for legislation addressed in this report would regulate the
mortgage lending, mortgage servicing, and mortgage-backed securities investing
industries. The mortgage lending industry would likely be considered “heavily
regulated.” However, credible arguments could be made that the other two,
especially, the MBSs industry, are not heavily regulated, which would strengthen the
argument that a taking has occurred. Yet, secondary market investors understand that
each mortgage they invest in could end up in default, and this possibility is accounted
for in the PSAs governing when and how servicers may modify these loans. While
a government imposed modification of the interest rates of certain mortgages
arguably would be a departure from the norm of servicers modifying mortgages in
accordance with the terms of PSAs, the more important question would seem to be
whether the statutorily imposed modification would have been allowed pursuant to
the governing PSA.
53 See, e.g., Appolo Fuels, Inc. v. United States, 381 F.3d 1338 (Fed. Cir. 2004). For this
purpose, the courts examine the regulations in place before the plaintiff acquired the
property in question.
54 Cienega Gardens, 503 F.3d at 1289.
55 Branch v. United States, 69 F.3d 1571, 1581 (Fed. Cir. 1995).
56 Concrete Pipe, 508 U.S. at 645-46.
57 Other “heavily regulated fields include: railroad labor disputes (Burlington N.R.R. Co. v.
United Transp. Union, 822 F. Supp. 797, 802 (D.D.C. 1991)); coal mining (Appolo Fuels,
381 F.3d, at 1349); liquor stores (People’s Super Liquor Stores, Inc. v. Jenkins, 432 F.
Supp.2d 200, 215 (D. Mass. 2006)); gambling (Hawkeye Commodity Promotions, 486 F.3d
at 440); and adult entertainment establishments (McCrothers Corp. v. City of Mandan, 728
N.W.2d 124, 141 (N.D. 2007)).
58 Cienega Gardens, 503 F.3d, at 1289.

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A MBS investor could make a stronger argument that the legislation in question
was not reasonably foreseeable where the statutorily imposed interest rate
freeze/reduction would not have been allowed under the governing PSA. The more
tailored the application of any interest rate freeze/reduction was to those borrowers
who would qualify for such a loan modification pursuant to the governing PSA, the
fewer MBS investors that would have stronger arguments under this prong.
Consequently, the scope of legislation might play an important role in a court’s
analysis under the investment-backed expectations prong of the Penn Central test.
Another factor that may strengthen a foreseeability argument, and thus augment
the government’s defense against a takings claim, is if the legislation in question is
considered to be a valid extension of Congress’s authority to pass laws on
bankruptcies. Because the modification of contract rights is such an integral part of
bankruptcy and because MBS investors should be aware that all mortgages could end
up in bankruptcy, these investors arguably should be less surprised by a change to the
bankruptcy laws that impose some form of interest rate freeze or reduction, than a
more broadly applicable statute passed pursuant to the Commerce Clause.59
Character of the Government Action. The third factor, the character of the
government action, is arguably of diminished importance in light of the Supreme
Court’s Lingle v. Chevron USA Inc. decision, where the Court stated unequivocally
that inquiry into whether a regulation advances some public purpose is not relevant
to the question of whether a taking occurred for Fifth Amendment purposes.60 The
effect Lingle will have on how future courts will apply the “nature of the government
action” factor is presently unclear. Historically, courts used this factor to assess
whether a regulation that impaired private contracts directly benefited the
government; disproportionately imposed the costs of a public benefit on a small
class; or was somehow the result of governmental bad faith.61 It is doubtful that a
legislatively imposed interest rate freeze/reduction would take rights from investors
and appropriate them to the government or would be enacted as a result of bad faith.
Rather, such legislation likely would be an attempt to help stem the current housing
downturn that is affecting the entire market. In the absence of specific legislative
language to delineate which mortgages would be covered by an interest rate
freeze/reduction, it is unclear if such legislation would impose a disproportionate
amount of liability on a small number of investors. The nature of the government
action authorized by the proposals in question would not appear to greatly augment
a takings claim, but more information would be needed to know for sure.
59 For more information on Congress’s powers pursuant to the Bankruptcy Clause, see the
“Legislative Authority to Pass an Interest Rate Freeze/Reduction” section of this report.
60 544 U.S. at 542 (“The ‘substantially advances’ formula suggests a means-ends test: It
suggests, in essence, whether a regulation of private property is effective in achieving some
legitimate public purpose. An inquiry of this nature has some logic in the context of a due
process challenge . . . But such a test is not a valid method of discerning whether private
property has been “taken” for purposes of the Fifth Amendment.”) (emphasis in original).
61 See, e.g., Tahoe-Sierra Preservation Council, Inc. v. Tahoe Regional Planning Agency,
535 U.S. at 333 (were it not for findings that the agency acted in good faith, the Court
“might have concluded the agency was stalling” and found a taking).

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Conclusion
In sum, it is unlikely, but possible that a court would assess an interest rate
freeze/reduction pursuant to the test outlined in the 1937 Supreme Court decision,
Vinton Branch. Courts would be more likely to assess such legislation as a regulatory
taking under Penn Central. If analyzed as a regulatory taking, it is unclear how a
court would decide an as-applied takings claim, especially without specific facts that
would allow an assessment of the severity of the regulation’s economic impact on an
individual investor’s property rights, which seems to be the most important Penn
Central factor.62 In such an analysis, a court could define the physical parcel as either
the securitized trust in its entirety or the investment tranches of each trust. If a court
adopts the tranche as the parcel interpretation, it is not difficult to envision some
tranches being significantly, if not entirely, diminished in value by an interest rate
freeze/reduction, due to the great diversity of investments in the mortgage securities
market. The economic impact in some of these situations could be substantial enough
to be considered a regulatory taking. Finding a taking would be far less likely if a
court accepts the argument that the physical parcel should be defined as an entire
trust.
It is impossible to predict at what level of economic impact a court would hold
that a taking has occurred, though in the past, it has almost always been quite high.
The strength of an impairment of investment-backed expectations argument would
likely turn on the scope of the legislation and how that coincides with the loan
modification authority provided by the governing PSA and if a court determines the
legislation to be passed pursuant to Congress’s bankruptcy powers. The nature of the
government action does not appear to warrant takings concerns on its own.
If a taking were found, then the legislation would stand, but the government
would be required to provide claimants just compensation for their losses. There is
no way to predict how much, if any, the government would be liable for in just
compensation claims, but in an industry valued at more than $1 trillion in 2006, the
potential liability could be large.63 Additionally, investors who lost large sums of
money due to an interest rate freeze/reduction could sue the government, and
regardless of the outcome of these cases, the litigation itself would likely be costly.
62 A facial challenge would not succeed under Penn Central because the particular facts of
plaintiffs’ property would be pivotal to a regulatory takings analysis. A facial challenge
would be possible if the court found an interest rate freeze/reduction to be a physical taking.
See, the “Physical Taking/Appropriation vs. Regulatory Taking” section of this report.
63 The value of securitized mortgages was around $2 trillion in 2006. See, CRS Report
RS22722, Securitization and Federal Regulation of Mortgages for Safety and Soundness,
by Edward Vincent Murphy.