To hear certain parts of the press tell it, the acting director of the Federal Housing Finance Agency (FHFA), Ed DeMarco, announced that the agency is willing to consider wholesale write-downs of underwater mortgages in a recent speech on the subject. However, a closer reading of DeMarco’s speech and the news stories shows that he actually understands the dangers of such a move. Even The New York Times noted that “His comments left doubt about whether he would change his long-held stance against principal reduction.”
The agency—which now controls both Fannie Mae and Freddie Mac, since those two housing giants essentially failed back in 2008—has been under heavy pressure from consumer organizations and some more liberal Members of Congress. In fact, many of them have been calling for DeMarco’s firing because of his opposition to such a move.
The press has focused on the fact that a new FHFA study unveiled at the recent speech showed a combined $1.7 billion reduction in expected losses for the mortgage entities under FHFA’s control. This would reduce the amount that taxpayers must pay to cover those losses. However, DeMarco also noted that under one of the many Obama mortgage refinancing programs, Treasury would provide a total of $3.8 billion in incentive payments for that action, thus leaving taxpayers with a net additional cost of $2.1 billion.
In DeMarco’s words:
So in summary, on just an NPV [net present value—a type of analysis] basis, this updated analysis would show a positive benefit to the Enterprises of $1.7 billion and Treasury incentive payments of $3.8 billion, which would imply a net cost to the taxpayer overall of $2.1 billion.
In his speech, DeMarco also warned of some of the unpleasant consequences of large-scale forgiveness of mortgage principal that supporters of such a move tend to overlook. For instance, he warned that such a program is unfair to the millions of homeowners who have sacrificed to pay their mortgages.
There are families that did not move up to that larger house because they weren’t comfortable taking the risk. Perhaps they had to save for college or retirement, and did not want to invest that much in housing. And there are people working multiple jobs, or cutting back on the family budget in many ways, to continue making their mortgage payments through these tough times. Many of these families are themselves underwater on their mortgage, even though they may have made a sizeable down payment.
DeMarco pointed out that a new public program of mortgage write-downs would encourage many responsible homeowners to default in order to get the same benefit that those who have stopped making mortgages would receive.
That means, will some percentage of borrowers who are current on their loans, be encouraged to either claim a hardship or actually go delinquent to capture the benefits of principal forgiveness?
DeMarco noted that even the $1.7 billion in projected loss reduction is based on the assumption that all underwater and delinquent homeowners would participate. He further stated that depending on the proportion who actually do, it would take only as few as an additional 20,000 responsible homeowners to stop paying their mortgages to eliminate those loss reductions.
In the speech, DeMarco further noted that almost half of the FHFA’s underwater loans also have a second mortgage on them, and an additional amount have private mortgage insurance. These loans would not be affected by a principal write-down, thus benefiting those lenders, and:
In the event of a subsequent foreclosure, the Enterprises [Fannie Mae and Freddie Mac] bear all the losses of the write down and the third party realizes all the benefits of it before incurring losses, if any.
There is nothing wrong with writing down the principal of a mortgage as a way to reduce losses, if it is acceptable to the owner of the mortgage and made voluntarily on a case-by-case basis. However, the mass principal write-down advocated by the Obama Administration and some housing advocates would be a serious mistake. Finally, as DeMarco noted, it would do much less to fix housing than other more responsible moves:
Whether Fannie Mae or Freddie Mac forgive principal or not, the universe of Enterprise borrowers potentially eligible for a HAMP PRA is well less than one million households, a fraction of the estimated 11 million underwater borrowers in the country today. This is not about some huge difference-making program that will rescue the housing market. (emphasis added)
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. Encouraging their continued success could have a greater impact on the ultimate recovery of housing markets and cost to the taxpayers than the debate over which modification approach offered to troubled borrowers is preferable.
DeMarco may have said that his agency is still studying the concept of large-scale write-downs of mortgage principal, but a close reading of his speech shows he understands why such a move would be very bad policy. He should not give in to pressure to ignore his own good judgment on this issue.