The Federal Housing Finance Agency (FHFA) is facing pressure from Congress to provide relief to underwater homeowners by lowering the principal on their loans, but FHFA Acting Director Edward DeMarco is not cooperating. He argues that lowering principal will only cost taxpayers more money by way of bailing out Fannie Mae and Freddie Mac while big banks are shielded from losses on the second mortgages many of them hold. There’s also an argument that the reduction does not help solve the problem of oversupply in the market, which many analysts say is one of the largest problems for the country’s real estate market recovery. For more on this continue reading the following article from TheStreet.
Fannie Mae and Freddie Mac continue to face pressure to reduce principal for homeowners underwater on motgages, but the debate still rages on who will end up paying for it.
The Federal Housing Finance Agency Acting Director Edward DeMarco remains fundamentally opposed to the idea of principal reductions, arguing that any large-scale reduction would only benefit banks.
In an interview with the Financial Times on Sunday, the regulator said policymakers who are pushing the agencies to reduce borrowers’s mortgage balances are in effect shielding banks from taking losses on their books.
That’s because banks in many cases hold the "second liens" on the same mortgages, additional loans taken by the borrower that are subordinate to the original debt that is owned by Fannie Mae and Freddie Mac. A blanket reduction on the mortgages on Fannie and Freddie’s books means taxpayers, who already have forked out more than $180 billion since bailing out the mortgage giants in 2008, will swallow yet another loss, while banks remain protected.
"If you do principal forgiveness, who is it benefiting?" DeMarco argued in the interview. "Doing principal forgiveness is what would protect the big banks."
The FHFA has the express mandate to minimize losses to the taxpayers. In an earlier analysis, the regulator said it would cost Fannie Mae and Freddie Mac – in other words taxpayers- $100 billion to reduce mortgage balances.
Policymakers, however, have been stepping up pressure on the agencies to reduce mortgage balances, arguing that restoring equity on borrowers’ homes will help reduce default rates.
Over 11 million borrowers are "underwater", meaning they owe more on their mortgages than what their homes are now actually worth. Underwater borrowers cannot repay their debt even if they manage to sell their homes. Refinancing at lower interest rates also tend to be extremely difficult without home equity, although government programs such as Home Affordable Refinance Program (HARP) now try to target underwater borrowers more actively.
The negative equity in the U.S. housing market is estimated at $700 billion, which presents a big overhang on the default rate.
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Recently, the Treasury introduced revised guidelines for modifications under the Home Affordable Modification Program or HAMP, offering for the first time incentives to both Fannie Mae and Freddie Mac to reduce principal on mortgages.
The FHFA has said it will review its analysis on principal reductions over the next few weeks, taking the incentives into account.
Last week, ProPublica reported that the housing giants are likely to tell the FHFA that principal reductions will likely save taxpayers money. And Freddie Mac’s CEO Edward Hadelman hinted at a conference organized by Housing Wire on Friday that the agencies might be more receptive to the idea following new incentives from the Treasury.
"I have to say recently the Treasury sweetened the program and tremendously increased the incentive payments in their offer to us," Haldeman said, according to a HousingWire report. "We will reevaluate that to see what may be in our economic best interest. If there are very large incentive payments — which could be 50 percent of what you could write down — it may be in our economic self-interest to participate in that."
That has encouraged some hope that the agencies might move forward with principal reductions after months of being steadfastly opposed to the idea. That’s welcome news for underwater borrowers.
But Mark Calabria, a former Senate Banking Committee member who is now director of financial regulation studies at the Cato Institute, argues that taxpayers are bearing the losses either way.
"It is a wash for the taxpayers whether Fannie or Freddie takes the hit or the Treasury gives them HAMP money to compensate for the losses," says Calabria. "But it gets policymakers around the constraint that DeMarco is bound by conservatorship to protect assets of the companies."
DeMarco’s top concern has been that principal reductions may wrongly incentivize borrowers who are fully capable of meeting their monthly obligations to deliberately default on their loans.
Yet other forms of loan modifications that target reducing interest rate on loans or extending the term of payment have the benefit of lowering monthly payments for borrowers without encouraging such moral hazard.
The regulator has also insisted that the bulk of the underwater loans lie with private lenders, so forcing the mortgage giants to take losses will make little dent on reducing the total negative equity in the market.
Laurie Goodman, senior managing director at Amherst Securities, is a major proponent of principal reductions and has found several flaws in FHFA’s analysis.
In recent testimony before Congress, she argued that the FHFA focused on a hypothetical model rather than looking at actual results under HAMP. Secondly, the FHFA does not consider any differentiation between loans with mortgage insurance versus loans without it when evaluating forgiveness versys forbearance. Generally it is less positive for the GSEs to consider principal forgiveness in cases where loans have mortgage insurance as mortgage insurers do not cover forgiven amounts. They do, however, cover forbearance.
Goodman suggests that the FHFA, therefore, do a more targeted form of principal reduction, focusing on loans with no mortgage insurance. "There is no question in my mind that forgiveness could be implemented for part of their book of business, without implementing it on the entire book of business. Precedence for this comes from the HARP program, where only loans issued before the June 1, 2009 cut-off date are eligible for a streamlined refinance," Goodman said.
She also suggests implementing measures to prevent moral hazard. "The first solution is to require that the borrower be delinquent as of a certain date, so performing borrowers do not intentionally go delinquent in order to get the principal reduction. The other choice is to establish a series of frictions so that only those borrowers who need the principal reduction take advantage of the program. This could involve the inclusion of a shared appreciation feature or other frictions to default."
But Calabria says that such targeted reductions as Goodman suggests are not practical for public agencies like Fannie and Freddie. " When they argue it should be targeted, Fannie and Freddie are not going to act like Bank of America and Wells Fargo. The working assumption is they are part of the government. It is very hard to say you are going to do everything on a case by case basis," he says.
The analogy he uses is the payment of unemployment benefits. "We don’t decide to pay only those who are actively looking for a job versus those who simply wait and collect unemployment benefits."
Even if they begin small, he believes political pressure will mount on the agencies to ramp up the program.
He also argues that programs aimed at principal reduction do not really solve the housing market’s problems, which is one of excess supply.
Still, the FHFA might not be able to escape the pressure from Congress to provide relief to borrowers in an election year.
This article was republished with permission from TheStreet.
