The plan is the mortgage holder only gets what the house is worth and loses the difference between the value and the outstanding mortgage amount.
That’s why it won’t happen. For one thing, the U.S. government is basically owned by the banking industry and therefore will never let such a thing take place without making the banks whole. Secondly, any municipality that does this sort of thing will find that its residents will never be able to get a mortgage in the future because of this added risk of loss for other future lenders.