by Jared Bernstein
Ed DeMarco, the director of the Federal Housing Finance Administration (FHFA), strikes me as a good man and a smart, dedicated public servant. But, in the interest of struggling homeowners and the larger economy, he should resign.
The reason for that harsh judgment is that he’s stonewalling on allowing Fannie Mae and Freddie Mac to reduce the principal on a targeted set of underwater mortgages, even though his agency’s own analysis shows it’s the right thing to do.
The FHFA is the agency that oversees Fan and Fred, the big mortgage companies now largely owned by taxpayers. Its mission is to support our system of housing finance to ensure stable, reliable, and affordable financing for homebuyers and homeowners.
Obviously, Fannie and Freddie screwed up during the housing bubble and bust—though contrary to a popular conservative meme, they didn’t inflate the bubble (instead they got in late and rode the market down)—which is why they’re in conservatorship. That’s another story.
This story is about an important way in which they could help certain underwater homeowners by writing off some of their mortgage debt, thus increasing their home equity. It’s called “principal reduction” (PR) and it has been shown to be a highly effective tool to help these folks avoid foreclosure.
Of course it's a big deal to reduce somebody's mortgage debt, and you have to carefully assess how debt reduction changes the likelihood of default and the ensuing losses to lenders, and in this case taxpayers. To their credit, that’s what DeMarco’s agency did, and they found that if the eligible homeowners targeted for PR under their program all participated, they’d stave off enough foreclosures to save taxpayers $1 billion.
Yet despite that win-win, they resist. Why?
DeMarco gave two reasons:
First, he cited 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 modification programs Fannie and Freddie are running. And anyway, the concern is moot because the Treasury has offered to pay additional administrative costs needed to implement PR.
DeMarco’s second, more serious, concern is that homeowners would strategically default in order to become eligible for a PR.
But this is actually unlikely, because the PR program is designed to make it an awfully risky bet for a homeowner to go for it when she doesn’t really need it. PR applicants have to demonstrate financial hardship, and must sign an affidavit confirming that they're either delinquent or at risk of default. Even if they do all this, they will first be evaluated for loan forbearance (like extending the length of the loan or lowering the rate of interest) as opposed to forgiveness.
As the Treasury pointed out yesterday in a letter to DeMarco: “[A] borrower would take a substantial risk by 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.”
Other new evidence supports that view. Fitch Ratings analyzed the PR program set up under the national mortgage settlement, and found that “[f]ew, if any, borrowers strategically defaulted to take advantage of mortgage servicer relief under the $25 billion settlement struck in March…”
So, what’s DeMarco's real issue?
A kneejerk response would be that he’s protecting investors, coddling banks or maybe kowtowing to servicers who make good (well, bad) money from defaults. But these mortgage are owned by the GSEs, not private banks, so that doesn’t really work here.
So, he’s just 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.
Which it is. But in unusual times, like the aftermath of the worst housing bubble implosion in decades, with 30-plus percent price declines, guess what? Write downs happen.
And keep this in mind: Without PR, it's not as if all these borrowers will pay up. Expected losses from the population eligible for PR (about 500,000 loans) are $45 billion!
Yet none of these realities appear to break through DeMarco’s aversion, even in the face of great nudging from the White House and Treasury. I respect him and his position, and I’m sure he thinks he’s doing the right thing.
But he’s not. So at this point, he needs to go.
Jared Bernstein served from 2009 to 2011 as chief economist to Vice President Joe Biden, and as a member of President Obama's economic team. He is currently a Senior Fellow at the Center on Budget and Policy Priorities, and an MSNBC contributor.