NEW YORK (CNNMoney.com) — Pressure is mounting on loan servicers and investors to reduce troubled homeowners’ loan balances…but the two largest owners of mortgages aren’t getting the message.
Fannie Mae and Freddie Mac, which are controlled by the federal government, do not lower the principal on the loans they back, instead opting for interest rate reductions and term extensions when modifying loans.
But their stance is out of synch with the Obama administration, which is seeking to expand the use of principal writedowns. In late March, it announced servicers will be required to consider lowering balances in loan modifications. And just who would tell Fannie and Freddie to start allowing principal reductions? The Obama administration.
Asked whether they will implement balance reductions, the companies and their regulator declined to comment. The Treasury Department also declined to comment.
What’s holding them back is the companies’ mandate to conserve their assets and limit their need for taxpayer-funded cash infusions, experts said. If Fannie and Freddie lower homeowners’ loan balances, they are locking in losses because they have to write down the value of those mortgages. Essentially, that means using tax dollars to pay people’s mortgages.
The housing crisis has already wreaked havoc on the pair’s balance sheets. Between them, they have received $127 billion — and recently requested another $19 billion — from the Treasury Department since they were placed into conservatorship in September 2008, at the height of the financial crisis.
Housing experts, however, say it’s time for Fannie and Freddie to start reducing principal. Treasury and the companies have already set aside $75 billion for foreclosure prevention, which can be spent on interest-rate reductions or principal write downs.
“Treasury has to bite the bullet and get Fannie and Freddie to participate,” said Alan White, a law professor at Valparaiso University. “It’s all Treasury money one way or the other.”
Though servicers are loathe to lower loan balances, a growing chorus of experts and advocates say it’s the best way to stem the foreclosure crisis. Homeowners are more likely to walk away if they owe far more than the home is worth, regardless of whether the monthly payment is affordable. Nearly one in four borrowers in the U.S. are currently underwater.
Principal reduction in the long run will lower the risk of redefault,” said Vishwanath Tirupattur, a Morgan Stanley managing director and co-author of the firm’s monthly report on the U.S. housing market. “It’s the right thing to do.”
Meanwhile, a growing number of loans backed by Fannie and Freddie are falling into default. Their delinquency rates are rising even faster than those of subprime mortgages as the weak economy takes its toll on more credit-worthy homeowners. Fannie’s default rate jumped to 5.47% at the end of March, up from 3.15% a year earlier, while Freddie’s rose to 4.13%, up from 2.41%.
On top of that, the redefault rates on their modified loans are far worse than on those held by banks, according to federal regulators.
Some 59.5% of Fannie’s loans and 57.3% of Freddie’s loans were in default a year after modification, compared to 40% of bank-portfolio mortgages, according to a joint report from the Office of Thrift Supervision and Office of the Comptroller of the Currency. This is part because banks are reducing the principal on their own loans, experts said.
So, advocates argue, lowering loan balances now can actually save the companies — and taxpayers — money later.
“It can be a financial benefit to Fannie Mae and Freddie Mac and the taxpayer,” said Edward Pinto, who was chief credit officer for Fannie in the late 1980s.
What might force the companies’ hand is another Obama administration foreclosure prevention plan called the Hardest Hit Fund, which has charged 10 states to come up with innovative ways to help the unemployed and underwater.
Four states have proposed using their share of the $2.1 billion fund to pay off up to $50,000 of underwater homeowners’ balances, but only if loan servicers and investors — including Fannie and Freddie — agree to match the writedowns. State officials are currently in negotiations with the pair.
“We remain optimistic that we can get a commitment from Fannie, Freddie and the banks to contribute to this strategy,” said David Westcott, director of homeownership programs for the Florida Housing Finance Corp., which is spearheading the state’s proposal.
If fanny and freddie came out with an announcement to make principal reductions happen, there would be another huge spike up in delinguencies.
It is like the government has no clue as to the unintended consequences of announcing goodies programs for the overleveraged.
If this happens all hell is going to break loose.
Why save when you can just default money into your bank account.
Calculated Risk also has two new entries up on HAMP.
A free $50K in exchange for a temporary (3-year) credit ding? What homedebtor *wouldn’t* sign up for that?
-Erica
Kingside hit the nail on the head – the line is very long for free money, especially when its an entire years’ worth of salary (national median IIRC is around 50k).
I’ve said it once, I’ve said it a thousand times
WHAT A STOOOOOPID COUNTRY WE LIVE IN !!!!!!!!!!!
Principle reductions? Go ahead and do it…as long as any property appreciation at the time of sale goes back into the local, state and federal tax coffers.
Now, how many people will volunteer for a principle reduction? Hint: None. Why? No free $$$.
I, for one, would be extremely happy to have my tax dollars go to pay off a bunch of McMansion’s mortgages. As a matter of fact, I was just saying that today to my wife as we drove down the road, swerving around some potholes out in front of the neighborhood’s poorly-performing school.
If fanny and freddie came out with an announcement to make principal reductions happen, there would be another huge spike up in delinguencies.
Yep, Kingside did nail it, but did so with classic understatement. Why wouldn’t everyone with an underwater mortgage — which is *most* of them — immediately not default? “Spike up” is putting it mildly.
If they’re going to give out free money, they should give free money to everyone to make it fair!
http://www.youtube.com/watch?v=HY-03vYYAjA
Why 50K…why not 200k or 500K? Why can’t hope and change just wave his magic wand and poof! Everyone owns their house free and clear? Like our clown academician said “Its all Treasury Money Anyway”, we can always print more. Let your grandchildren’s grandchildren worry about it
Sometimes, it feels like a bunch of preschoolers have taken over our government.
Is there any consideration if the refinance money went to off road vehicles and plastic surgery?
A pricipal reduction can actually make sense to the loan owner (Fannie/Freddie and the banks) in some circumstances. If a house has a loan for $400k on it but is now only worth $150k (a realistic scenerio in some areas), reducing the principal to $250k is a much better deal for Fannie/Freddie/the banks/the government than foreclosing on it and selling it for $150k (selling it also incurs costs, so they would actually get even less than $150k).
OK, Geotpf, that borrower who gets a $250k principal will start bragging to his/her friends and neighbors about the great deal he/she got, and everyone else will feel like a fool for paying their mortgage.
Fannie/Freddie is an arm of the govt. in implementing policy, so really, that principal reduction makes no sense at all.
If principal reduction is going to be in the game plan, then bring back the cram down rule for bankruptcy cases and make a borrower have to file for BK, qualify, and be subject to creditor’s claims for fraud, etc. in BK court. Don’t just give out principal reductions because foreclosure is viewed as a problem, not a solution.
no reductions-no deals—let the foreclosure process work and let buyers that are waiting in the wings buy—-it is utterly ridiculous to reduce mortgage balances especially for anyone that did a cash out refi—its like saying steal and steal some more—
They are going to keep wanting to design different programs to assist, and principal reductions are next.
Here’s my plan:
If the borrower makes every (loan-modified) payment on time for ten years, and you still have negative value, then the mortgage to be reduced to fair market value. If there is equity, borrower gets 100% of it.
I used to be against principle reductions as they are unfair. Savers will pay more taxes to help out debtors. This program uses government money for both portions of the contribution (FNM&FRE = taxpayers)
However, in the long run lower home prices will make the country better off. Less principle will mean lower listings prices in the future. Think of all the people that do not list cause they owe too much, this will solve that. Reductions cannot be worse then letting debtors live rent free for 2+ years.
I don’t have a problem with principle reduction. I have a problem with tax-payer subsidized principle reduction! If the lender wants to cut its losses via a principle reduction, then go for it.
You know there is a problem with the plan when the government needs to provide the ‘incentives’. I’m tired of providing the ‘incentives’ (including my buying of mortgages to keep rates mortgage rates low).
Reductions cannot be worse then letting debtors live rent free for 2+ years.
Those aren’t all the choices. The one most here would prefer is quick, orderly foreclosures.
I agree on foreclosures. Does not seem like the government will let that happen. So now we need to decide between other two bad choices.
“Does not seem like the government will let that happen.”
It will happen just at a “measured” pace. Principle reductions only make sense if you reduce every outstanding loan balance. Ultimately this is what the government is trying to accomplish with inflation but they are pushing on a string:
http://www.cnbc.com/id/37229659
“U.S. consumer prices unexpectedly fell in April, the first decline in a year, and the core annual rate recorded its smallest gain since 1966, suggesting scope for the Federal Reserve to keep interest rates near zero for some time.”
I believe the FED will become more desperate in their attempt to stoke inflation and perhaps they will eventually succeed. But the Japan scenario is looking more possible particularly with the recent strengthening of the dollar.
I think the government is in a very very precarious situation with respect to these principle reductions. One wrong move and they will suddenly have a situation were everyone stops paying their mortgage simultaneously demanding a handout.
If anything was to be done to reduce foreclosures, I would have preferred to see reductions in rates for the distressed rather than principle, with some kind of deferral plan for people hit by unemployment. Someone who bought a home as a home rather than as an investment would probably be inclined to continue making affordable payments on an underwater family home; those who could afford to pay but only cared about the profit potential should have received no assistance, except perhaps a swifter foreclosure to “help” them out the door when they stopped making payments.
Whose going to pay for those interest reductions? Tax payers. The banks won’t be able to pay interest rates lower (or even equal) to what they can borrow at. Either we are just throwing good (taxpayer) money after bad, or the gov’t is going to find a way to inflate their way out of this.
As a saver, I would rather we let assets depreciate. Given the indebtedness of our government, that won’t happen. It’s no wonder people don’t save. Unfortunately, we’ll be trading some short-term relief for long-term pain (inflation). Deflation would probably be short-term pain for long-term relief. What a mess.
The banks do not own the mortgages the government does. Since the government has said they will bail out FNM and FRE bondholders that means taxpayers pay for it. It is horrible.
Lets just get it over with, two options foreclosure and principle reduction. I prefer foreclosure, but that will not be allowed to happen. Therefore principle reduction as a way to lower home prices.
I would have preferred to see nothing at all done to prevent foreclosure, except in cases where people who were paying their mortgages get hit with unemployment or other catastrophic events, but that’s clearly not going to happen.
Taxpayers will ultimately end up paying for whatever foreclosure prevention schemes are tried, and neither scheme will keep prices inflated. Whether principles or rates are reduced prices are still going to be set by what new buyers are willing to pay. Not reducing the principle would at least have retained the idea that when you buy something and the price goes down you lose money.