Despite the fact that their own analysis finds that it would save them and the taxpayer money, Ed DeMarco, head of the FHFA, just announced that Fannie and Freddie would not do principal reductions under HAMP to help a subset of underwater borrowers avoid default.
His announcement surprised a lot of us following this development, since we learned yesterday, according to the WSJ, that “…a new analysis by the regulator suggests that taxpayers could actually benefit from the move, according to people briefed on the findings…Fannie and Freddie could save about $3.6 billion more than current loss-mitigation approaches by reducing balances for some borrowers that owe much more than their homes are worth, these people said.”
Once you net out the subsidies from the Treasury to the GSEs, the savings to taxpayers still amount to $1 billion. Not a huge number in this biz, but given the strong record of targeted PR in helping struggling homeowners, as long as the net benefits are positive, the FHFA should get in the game.
Yet, they resist. Why?
DeMarco gave these reasons. First, he expressed concerned about the administrative costs of implementing PR. I take this as the first hint that he’s got a thumb on the scale against it, because I don’t recall his raising this concern about the numerous other loan mod programs the GSEs are running.
But the concern is moot anyway because the Treasury has offered to pay “the additional administration costs required to implement HAMP-PRA” (that’s the PR program).
DeMarco’s second, more serious concern, is that homeowners would strategically default in order to become eligible for a PR.
But as I’ve stressed in past posts on this, HAMP-PRA eligibility is designed to make it an awfully risky bet for a homeowner to try this. PR applicants have to demonstrate financial hardship and they must be either delinquent or at risk of default (and they have to sign an affidavit confirming their tough economic situation). Even if they do all this, they will be first evaluated for loan forbearance as opposed to forgiveness. As the Treasury points out in a letter to DeMarco today (worth reading if you want deets on all of this):
“…a borrower who defaults cannot be certain that he and she will obtain a HAMP modification, much less…principal reduction. Therefore, a borrower would take a substantial risk be deliberately defaulting: they would have to choose to damage their credit for years to come and perjure themselves on the chance that they would be found eligible for the program.”
And here again, Treasury offers to “include an asset test or other type of hardship screen to maximize the likelihood that only borrowers with genuine hardships receive principal reduction.”
It’s also worth noting that some new empirical evidence doesn’t support DeMarco’s fears about strategic defaults. Under the national mortgage settlement, there’s a PR program, and Fitch Ratings analyzed the problem of strategic defaults, finding that:
[f]ew, if any, borrowers strategically defaulted to take advantage of mortgage servicer relief under the $25 billion settlement struck in March…
In fact, the percentage of current underwater borrowers moving to delinquent status, or the roll rate, shrank to 2.8% in June from 3.1% in February, a trend consistent since before a deal was reached with mortgage servicers to settle past foreclosure abuses…
“Fitch views strategic defaults as an ongoing concern,” the credit ratings agency said in a report Monday. “That said, there does not appear to be any sign yet of a material change in the behavior of underwater borrowers attempting to strategically default to qualify for a reduction.”
So, what’s really going on here?
A kneejerk response would be that DeMarco is protecting investors, coddling banks so they can comfortably extend and pretend, or maybe kowtowing to servicers who make good (well, bad) money from defaults. But that doesn’t really hold here, as these mortgage are owned by the GSEs, not private banks.
So, he’s protecting the taxpayer, right? Wrong, according to his agency’s own analysis!
The clue to what’s really going on is that DeMarco did not evince anything like this level of caution with the other mod programs — the ones that do forbearance instead of forgiveness. So one can only conclude that he’s got a deep aversion to reducing principal. This is something you often see among bankers and lenders who view any sort of write down as the unacceptable breaking of a contract.
And, of course, it is…i.e., breaking a contract. But in unusual times, like the aftermath of the worst housing bubble implosion in decades with 30+% price declines, guess what? Write downs happen.
Moreover, remember: the counterfactual here from the perspective of lenders, or in the GSEs case, taxpayers, is not that all these borrowers pay up. Expected losses of the eligible population for HAMP-PRA (about 500,000 loans) are $45 billion!
Targeted PR is a loss mitigation tool, one that’s already proven helpful in the private mortgage market, and one that could be more so if the GSEs would get on board, as their own analysis suggests they should. To do so would help struggling, underwater homeowners avoid foreclose, provide some marginal taxpayer benefits, and help the macroeconomy as well.
But one has the feeling that none of this will keep director DeMarco from his Olympian performance to stonewall PR’s, even in the face of great nudging from the White House and Treasury. I respect him and his position, and I believe he thinks he’s doing the right thing. But at this point, I really think the guy needs to step aside.