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FHFA battle: Mortgage principal reductions versus forbearance

The foreclosure crisis continues to rage in America. Could mortgage giants Fannie Mae and Freddie Mac do something about it?
The foreclosure crisis continues to rage in America. Could mortgage giants Fannie Mae and Freddie Mac do something about it?
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NPR and ProPublica have been pressing forward with their reporting on the doings at Fannie Mae and Freddie Mac, the two mortgage giants that were put into government conservatorship during the financial crisis. Jesse Eisinger remains the lead reporter on the case. In January, he detailed how Freddie was allegedly structuring its investment portfolio to profit from mortgages that it refuses to refinance (I and others thought Eisinger misinterpreted Freddie's motives here). Now he's looking at why the Federal Housing Finance Administration (FHFA), Fannie and Freddie's regulator, won't support principal reductions.

Here's a salient section:

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.

Eisinger appeared on KPCC's "AirTalk" this morning to go over the issue. The point of tension is that with both Freddie and Fannie saying that they think reductions make sense, DeMarco looks obstructionist. He remains in his job, in fact, because Republicans in Congress blocked an Obama effort to unseat him. So he's been "acting director" for a while.

The bottom line is that Fannie and Freddie reportedly think that principal reductions will save the taxpayer money over the long haul because you'd see fewer people pushed out of their homes — specifically people who are "underwater" on their loans, owing more than the house is worth in the market:

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.

DeMarco has opposed principal reductions for two reasons: first, because he thinks it would cost Freddie and Fannie too much up front, perhaps $100 billion; and second, because he believes Congress hasn't empowered the FHFA to authorize reductions.

I don't think I'm going out on a limb when I say that Eisinger doesn't think DeMarco and the FHFA are pursuing a good policy here.

DeMarco favors principle forbearance. The difference is simple: principal reduction takes a $400,000 mortgage on a home that's only worth $300,000 and writes it down to be a $300,000 mortgage. The $100,000 difference becomes a loss to the taxpayer, but it enables the homeowner to avoid default and provides him with an incentive to stay in the game.

Principal forbearance involves reducing the borrowers monthly obligation, much like in a writedown, but the size of the loan doesn't change. You have a $400,000 mortgage. House is worth $300,000. You can't make the payments and can't refinance because you're underwater. So you get to operate like your have a $300,000 mortgage for a while, but you're still responsible for the $400,000 total.

I wrote about this in February:

The FHFA is drawing a clear contrast between its loans and the loans of commercial banks. Those banks should consider principal writedowns because their borrowers are headed for foreclosure in far greater numbers. Freddie and Fannie, meanwhile, have close to two-thirds of their borrowers current — even the ones who are underwater. 

The question is whether this whole "mission" that Freddie and Fannie together are allegedly serving is important enough to dodge writedowns. The FHFA's analysis says "No" to new loans but "Yes" to longer loan terms. In the agency's own words, principal forbearance means "no interest is charged on a portion of the underwater amount." You're right if you think that sounds like a very modest solution. But if most of your loan book was current — even a majority of the underwater slice — you'd probably be reluctant to bow to political pressure to do writedowns.

What enrages some members of Congress and much of the public is that the FHFA is acting very businesslike here — and the business it's liking is the business of the taxpayer. It could, by its own estimation, pour another $100 billion into the mortgage crisis. But you can just feel its reluctance to give a big break to borrowers it doesn't think are going to default. For the ones it does, it can noodle with the interest payments. But that just means the agency is counting on borrowers being OK with swimming underwater for a long time.

DeMarco has been gamely fighting off the reduction wave for a while. But now it's the FHFA's old argument versus Fannie and Freddie's new numbers (which no one has actually seen yet). So even if DeMarco is right and forbearance does just as effective a job of keeping the homeowners in the home as reduction, he's going to have a much more difficult time making his usual case when pressed to do things differently.

That said, there's no question, either at Fannie and Freddie's or FHFA, that the reductions will cost money up front. The big question is whether you believe that the money spent, by the taxpayer, will be an investment that pays dividends later or a liability that's never recovered.

Follow Matthew DeBord and the DeBord Report on Twitter.