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Why Millions Won't Get Help From Big Mortgage Settlement

Freddie Mac and Fannie Mae's opposition to principal reductions on mortgages means about half of homeowners in the U.S. couldn't qualify for the most significant help from banks' settlement today with states.

The Obama administration is billing today's $25 billion agreement between most states and five banks that engaged in flawed or deceptive practices as a big win for struggling homeowners.

Most of the money in the settlement isn't a penalty, or a fine levied on the banks. Instead, the biggest slice of the settlement will be money banks put toward principal reduction -- reducing the amount owed by struggling or underwater borrowers. (Banks will also put smaller amounts toward refinancing and other ways of helping people get back in control of spiraling debt.)

Getting a break on their mortgages could help the millions of homeowners who owe more on their home than it is worth. But many of them won't qualify -- thanks to government-owned Fannie Mae and Freddie Mac.

The two mortgage companies, who were bailed out by the government in 2008, were described by former Obama economic advisor Jared Bernstein as "the boulder" in the way of principal reduction. Their federal regulator, the Federal Housing Finance Agency, is tasked with maximizing profits from the companies -- and thus minimizing taxpayer losses. The head of the agency, Edward DeMarco, argues that allowing principal reductions would result in a big loss for Fannie and Freddie and ultimately taxpayers.

The two companies aren't directly part of the settlement. They don't service mortgages, or deal directly with borrowers. But Fannie and Freddie do guarantee or own roughly half of the mortgages in the U.S. They also hold more than 3 million of the nation's nearly 11 million underwater mortgages. Since Fannie and Freddie are backing the loans -- and are the ones who will take a loss if the mortgage isn't paid back in full -- they often have a veto on whether homeowners get a break.

Even if Bank of America, for example, services your mortgage, you would not be eligible for principal reduction if Freddie or Fannie back it.

Principal reduction is being pushed heavily by the Obama administration as a way to lower the rate of foreclosures. The administration recently tried to encourage Fannie and Freddie by offering to triple incentives for principal reduction. So far, the companies and their federal overseer, DeMarco, have declined to do so. An FHFA spokesperson said that the agency is "not a party to the agreement. We await a copy of the agreement to determine its implications."

Lowering the amount of money owed on a loan would result in at least short-term losses for Fannie and Freddie, as well as to any other investors in mortgages that are reduced. But many economists and analysts argue that Fannie and Freddie would ultimately benefit since such moves could help restore the health of the housing market as a whole.

The reluctance by Fannie, Freddie and others to take on principal reduction is partly why the administration's mortgage modification programs have been so ineffective.

The settlement does have potential benefits for future borrowers, including new protections and disclosures to prevent what Attorney General Eric Holder called "abusive practices" by the mortgage industry.

A small portion of the overall settlement -- about $5 billion -- will amount to penalties for past abuses by the banks. Some of it will go to state governments that were afflicted by banks' shoddy practices, and some of it will go directly to about 750,000 homeowners who were foreclosed upon. If you lost your home, you could get up to $2,000.

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