The top regulator for 60 percent of America's home mortgages opened the door a bit on helping underwater homeowners through principal reduction, but he's not totally on the bus yet.
Under pressure from Democrats in Congress, Edward DeMarco, the head of the Federal Housing Finance Agency, said Tuesday the idea might make sense, although more study was needed. He also repeated the reasons he has been opposed to the idea, including the risk that homeowners who aren’t in trouble will also ask to have their mortgage balances cut.
“Most Americans that are underwater on their mortgage realize they've signed a contract, they’ve got an obligation to make that payment and in fact they are," DeMarco said in speech at the Brookings Institution in Washington D.C. They should be encouraged to do so, he added.
Since the collapse of the housing market in 2006, the value of American homes has fallen by some $7 trillion, leaving roughly 11 million homeowners owing lenders more than their homes are worth.
Those homeowners, unable to sell their house before they buy a new one, are effectively locked out of the housing market. Five years into the housing recession, they’re also more likely to consider walking away from their mortgage, adding to the backlog of foreclosures.
To help stabilize the housing market, proponents of principal reduction argue that both homeowners and lenders are better off avoiding those defaults. The recent mortgage settlement between 49 states, several federal agencies and five large banks is hoping to promote the practice by providing those lenders with incentives to cut loan balances.
"There is increasing data available, we believe, that shows that... principal reduction can be good not only for homeowners and communities, but for investors as well," Shaun Donovan, Secretary of Housing and Urban Development, told a Senate panel earlier this year. "It can allow people to pay [their bills], stay in their homes and increase the value of those mortgages."
But those arguments haven't yet persuaded Edward DeMarco, head of the agency that regulates Fannie and Freddie, to begin cutting balances on the 29 million mortgages owned and overseen by Fannie and Freddie.
On Tuesday, Demarco reviewed the track record of the other tools the agency is using to keep people in their homes or minimize losses to taxpayers when they can no longer afford to make their payments. Those include cutting the interest rate, extend the term of the loan or offering principal “forbearance” – which postpones the repayment of a portion of a loan balance, but doesn’t permanently reduce it.
In his analysis, DeMarco repeated his contention that instituting a policy of cutting loan balances would cost taxpayers more than would relying on the existing tools to prevent defaults. He also cited data on Fannie Mae’s own loan modifications showing that lowering monthly payments is a more effective way of preventing defaults than cutting principal.
But he left open the possibility that "Fannie Mae and Freddie Mac might apply principal forgiveness.” DeMarco said he expected to wrap up the agency’s latest review of the issue in a few weeks.
So far, DeMarco has steadfastly refused to consider cutting mortgage loan balances in the face of months of sharp criticism, including a recent letter from more than 100 House Democrats, especially those in districts hit hardest by the housing collapse.
In February, Democratic Rep. Elijah E. Cummings, Ranking Member of the House Committee on Oversight and Government Reform, and committee member John Tierney (D-Mass.) said in a letter to DeMarco that his refusal to apply principal reduction was “ based more on ideology and the fear of political backlash than on a straightforward analysis of the interests of American taxpayers.”
The debate took a bizarre twist last month when FHFA's inspector general, who is charged with detecting "fraud, waste and abuse" in the government-controlled mortgage giants, reported that Freddie Mac alone could save taxpayers “significant” sums of money if it pressed the companies servicing its mortgages to modify more loans. But the amounts to be saved were redacted at the request of FHFA "and/or" Freddie Mac, according to the report.
Despite DeMarco’s latest review of mortgage writedowns, “the jury is still out on whether he will act to serve both homeowner and taxpayer best interests,” Cummings said in a statement Tuesday.
Proponents of the idea argue that, if it's applied to defaulted mortgages that could be made to perform again, principal reduction would save money over the long term.
“Private lenders are doing it for an increasing share of their (mortgage portfolios) when it makes sense,” said Andrew Jakabovics, a research director at Enterprise Community Partners, Inc. “If (Fannie and Freddie) aren’t willing to do it there are plenty of investors who are buying these notes because economically it makes a lot of sense.”
The White House earlier this year said it would offer financial incentives, drawn from Troubled Asset Relief Program funds used to support other government mortgage programs, if Fannie and Freddie would adopt principal reduction as part of its mortgage relief efforts. So far, the government has spent more than $150 billion in taxpayer funds to prop up the money-losing mortgage agencies.
Proponents of cutting some mortgage balances argue that the longer underwater homeowners consider their options, the more likely they are to walk away from their mortgage. Those “strategic” defaults would prolong the housing recession and force even more homeowners underwater.
But DeMarco repeated his concern Tuesday that offering principal reduction could prompt other homeowners who are current on their loans to ask to have their loan balances cut.
“The far larger group of underwater borrowers who today have remained faithful to paying their mortgage obligations are the much greater contingent risk to housing markets and to taxpayers,” DeMarco said in his Brookings speech Tuesday.
Some private analysts say that risk may be unknowable.
"We’re in uncharted territory in terms of how people behave,” said Mark Fleming, chief economist of CoreLogic, a real estate research firm. “But we do have an understanding that someone who is underwater is less willing (to keep up with their mortgage payments).”
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