FHFA Regulator, Edward DeMarco, charged with oversight of mortgage giants Fannie Mae and Freddie Mac, is under heavy pressure from the Obama administration and Democrats in congress to allow reductions of mortgage principal for qualified borrowers.
You may recall that the FHFA was created by the Housing and Economic Recovery Act of 2008, to oversee the two GSE’s, which together account for almost 3 quarters of the publicly held debt of the United States (almost 7 trillion dollars).
The secondary mortgage market is the backbone of the U.S. housing industry. Fannie and Freddie account for 65% of that market. Insuring the solvency of Fannie and Freddie is, at this point in time, essential to the survival of the housing market and the widespread availability of mortgage loans. The taxpayers are on the hook for the losses incurred by either of these agencies. And indeed, as I have documented in recent articles, the taxpayers are currently backing virtually the entire secondary mortgage market in the U.S., via Fannie, Freddie, FHA and USDA, which at present, account for around 95% of all new mortgage loans being issued.
So, in short, it is serious business to make any decision that could be fraught with unintended consequences. Mr. DeMarco is right, in my opinion, to insist on giving this matter his most careful study and consideration, before making any decision to proceed with any plan to reduce mortgage principal. But of course, careful study and consideration is not something that the government is given to doing, especially in an election year, when it is perceived that writing down these mortgages could help the current administration politically. At least that is the perception among Democrats, many of whom are demanding that DeMarco be fired for “standing in the way of progress in the housing market”.
But when you look at the big picture, this smacks of nothing more than election year political wrangling.
First, Fannie and Freddie have already been the primary target of most of the current crop of housing initiatives for foreclosure aid, loan modifications and other programs for borrowers, with very little success to show for it. There are dozens of programs already in place. But these programs can only be applied to Fannie and Freddie owned mortgages, leaving the rest of the mortgages owned by other parties subject to totally different rules.
Secondly, while some in congress and the media would have the public believe that principal write-downs would help home owners and stem foreclosures, the real fact is that it would be at taxpayer expense. The banks are not going to lose anything.
Don’t be fooled into thinking that the recent settlement agreement between the states and the big banks means that the banks have suffered. They haven’t and they are not going to. At the end of the day, any principal reductions would be paid for by the taxpayers, not the lenders who made the loans, many of which should never have been made. That 25 billion dollar bank settlement is a joke when compared with the nearly 7 trillion dollars in mortgage debt that is guaranteed by the taxpayers via Fannie and Freddie. If you did enough principal reductions to simply stop all of the foreclosures, it would simply cost the taxpayers billions more to pay off the investors in those notes, the lenders…who only invest in such items because they are taxpayer insured, so they know they can’t lose. But even the lenders and investors in such notes do not favor principal write downs because of the potential future impact on contract law.
Which is a third potential dilemma: Rewriting enforceable contracts, signed by competent parties who agreed to be responsible for the debt could open a can of worms that could undermine the future of the secondary mortgage market. This could have a very negative impact on the future of the U.S. mortgage market from the perspective of attracting private investors back into the market.
And finally, there are justifiable worries about moral hazard. Frankly there is enough moral hazard on the side of government insured loans to argue that banks and lenders should never again have the luxury of making irresponsible loans that are guaranteed and paid for by the taxpayers. That is one form of moral hazard that contributed significantly to the housing bust, but is rarely discussed.
In the context of the position of FHFA and a decision to allow principal reductions, the question remains, “if you allow a program that specifically benefits those who are not making their mortgage payments on time, is it not reasonable to assume that this would encourage more borrowers to default, as a way to qualify for a principal reduction on their loans?” And especially so if they are current on payments, but owe more than their home is now worth.
Principal write-downs would do little to help home values, as reducing the amount you owe, down to the current value of the home might reduce the foreclosure rate to some degree, but the value of the homes would still be where it is today. And over the past 4 years, the damage to the housing market has already been done.
(If the banks thought for one minute that principal reductions would boost housing market values, they’d be all over it, because it would bolster the value of their worthless second mortgages, which are still a big problem)
If you ask me, Mr. DeMarco has plenty of reason and responsibility to be careful with any decision that would add to the already staggering taxpayer burden. Only political parties fighting for their life could justify such reckless last minute behavior after spending 4 years coming up with one poorly executed plan after another. But after all, when it comes to housing policy, the federal government has a long history of poor decision making inspired by political expediency. ***
Donna S. Robinson is a 16 year veteran of the real estate industry and a staff writer for Realty Biz News. She is an active real estate investor who also provides coaching and consulting services on residential real estate investing. You may join her email list on her website at www.RealtyBizConsulting.com