Update: On Friday, following the publication of this story by ProPublica and NPR, lawmakers called on the Federal Housing Finance Administration to provide Congress with the new analyses on principal reductions by Fannie Mae and Freddie Mac. In addition, Illinois Attorney General Lisa Madigan urged FHFA to immediately implement appropriate principal reductions to home loans held by Fannie Mae and Freddie Mac.
A version of this story was co-published with NPR News and broadcast on NPR’s Morning Edition.
New analyses
by mortgage giants Freddie Mac and Fannie Mae have added an explosive new
dimension to one of the most politically charged debates about the housing
crisis: Whether to reduce the amount of money beleaguered homeowners owe on
their mortgages.
Their
conclusion: Such loan forgiveness wouldn’t just help keep hundreds of thousands
of families in their homes, it would also save Freddie
and Fannie money. That, in turn, would help taxpayers, who bailed out the
companies at a cost of more than $150 billion and are still on the hook for future
losses.
The analyses,
which have not been made public, were recently presented to the agency that
controls the companies, the Federal Housing Finance Agency, according to two
people familiar with the matter. Freddie Mac’s meeting with the FHFA took place
last week.
The decision
of whether to allow such reductions rests with Edward DeMarco,
the acting director of the FHFA, who has steadfastly opposed so-called
principal reductions on the grounds that it’s a bad business decision for the
companies and would cost taxpayers money.
Many
economists and policy makers contend that cutting principal — the amount
of money lent to the homeowner — is one of the best solutions for keeping
people in their homes and to bolster the fragile economic recovery.
But this
solution has raised passionate opposition: Many borrowers who are paying their
mortgages every month feel it is unfair. Why, they ask, should they have to keep
paying the full amount while others who took a loan they ultimately couldn’t
afford or saw their house plummet in value get a break? Some economists and
policy makers argue that borrowers might intentionally stop paying their
mortgages to score a reduction. Indeed, the prospect that the government would help
troubled homeowners was a spark that created the Tea Party movement.
The
companies’ new analyses were prompted by new Obama administration subsidies the
government is offering Fannie and Freddie to reduce a homeowner’s loan. But
it’s unclear whether DeMarco will take advantage of
those incentives.
He declined
to be interviewed for this story. But in a statement to ProPublica and NPR, DeMarco said that FHFA is assessing its position in light
of the new Obama financial incentives, offered under the Home Affordable
Modification Program, or HAMP. “As I have stated previously, FHFA is
considering HAMP incentives for principal reduction and we have been having
discussions with [Freddie and Fannie] and Treasury regarding our analysis.”
Both Fannie
and Freddie declined to comment.
As an
independent regulator, DeMarco does not answer to the president and can make
policies that the administration opposes. Obama sought to replace DeMarco, but his nominee was blocked by Republicans in the
Senate, which must confirm the agency head.
As recently
as Feb. 28th, DeMarco told the Senate banking
committee, “Both companies have been reviewing
principal forgiveness alternatives. Both have advised me that
they do not believe it is in the best interest of the companies to do so.”
Overall, principal
reductions could help millions of borrowers who owe much more on their homes
than their houses are worth, economists estimate.
And principal
reductions can help lenders, because foreclosure often leads to bigger losses than
reducing the amount owed. The
biggest banks have long employed such reductions to curb their own losses.
The new
analyses by Freddie and Fannie were done to assess the new
financial incentives that the Obama administration announced in late January. ProPublica
and NPR have not read the analyses, but two people described key aspects of
them. The companies now find that reducing principal on troubled mortgages has
a “positive net present value” — in other words, that doing it would
bring in more money for the companies over the life of the loans than not doing
it.
The two
companies’ analyses showed that upwards of a quarter million
borrowers who owe more on their mortgages than their homes are worth
could benefit from principal reductions. The companies would take a loss
upfront, but over the long run these mortgage modifications would save the
companies money because they would lead to lower default rates.
Experts have
said that principal reductions are one of the best tools for helping homeowners
stay in their homes.
“Principal
reduction works,” said Mark Zandi, chief economist of Moody’s Analytics. “If
someone gets a reduction in their principal amount, it gives them a real
powerful hook to really fight to try to hold onto the home, even if things
aren’t going financially right for them.”
The
re-default rate for homeowners who receive a principal reduction is lower
compared with the rate on other types of types of mortgage modifications, Zandi
said.
Zandi
estimates that principal modification could benefit 300,000 to 500,000
homeowners whose mortgages were backed by Fannie and Freddie. “And that would
make a substantive difference,” he says, in helping the housing market and
boosting the economy.
“It saves
taxpayers money and makes homeowners less likely to default,” said Zandi. Given
the Obama Administration’s policy changes, “I’m now perplexed why DeMarco is not more fully engaged” in supporting principal
reductions.
Not everyone
supports principal modifications. Anthony Sanders at George Mason University says
that implementing such reductions risks triggering a wave of strategic defaults,
where people stop paying on their homes in order to qualify for a break. “DeMarco is absolutely right,” he says.
The Obama
administration’s new initiative triples the subsidies. They now range from 18
cents to 63 cents on the dollar, based on conditions such as how deeply
underwater a borrower is. The subsidy works out so that generally the Treasury
would pick up about half of Freddie and Fannie’s principal reductions, according
to a person familiar with the incentives.
The subsidies
are funded through HAMP, which used money from the Troubled Asset Relief
Program (TARP), widely known as the bank bailout. Much of that money has not been spent.
Under DeMarco, the FHFA has allowed Fannie and Freddie to do
principal forbearance, rather than principal reductions. In such a
modification, borrowers’ monthly payments are reduced, but they still must
eventually pay back the entire loan. Critics contend that such modifications
don’t provide as much incentive as principal reductions for borrowers to keep
paying.
Despite the new
findings, it still might not make sense for Fannie and Freddie to do principal
reductions. Such a program might require substantial and expensive changes to their
computer and accounting systems and might distract from the core business. In
his statement, DeMarco said, “FHFA’s previously
released analysis concluded that principal forgiveness did not provide benefits
that were greater than principal forbearance as a loss mitigation tool. FHFA’s
assessment of the investor incentives now being offered will follow the previous
evaluation, including consideration of the eligible universe, operational costs
to implement such changes, and potential borrower incentive effects.”
Yet even
before the Obama administration’s new subsidies, the FHFA’s own data supported principal
reductions for some
borrowers, despite its opposition to using them, some
argued. An
American Banker analysis of the FHFA study, which the agency sent to
Congress in January, suggested that principal reduction shouldn’t be rejected
so unequivocally.
