Principal reductions are the government’s next bailout device, and they are getting pushed hard. Excerpts from an article at thestreet.com:
NEW YORK – 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 FHFA has said it will review its analysis on principal reductions over the next few weeks, taking the incentives into account.
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.
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.
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.