After months of arm-twisting, Financial Housing Finance Agency (FHFA) chief Ed DeMarco seems to be succumbing to pressure on mortgage giants Fannie Mae and Freddie Mac to introduce principal reductions – aimed at helping borrowers, but alarming bankers.
But in the end, will they help ease the ongoing mortgage crisis?
Principal reduction – basically, forgiving part of a loan – can be a useful tool to help deeply underwater borrowers stay in their homes, proponents argue. Studies have shown that underwater borrowers are at high risk of default, and the more people who default and go into foreclosure, the more overall prices are dragged down. Forgiving a portion of the loan for underwater borrowers would reduce that risk and stabilize prices, hastening the housing market recovery, according to many homeowner advocates.
Up to now, such arguments have largely fallen on deaf ears at Fannie and Freddie, with overseer FHFA taking the view that offering a principal reduction to some underwater borrowers could also tempt those who are current on their loans to deliberately stop paying in hopes of getting the same deal.
Applying Pressure
But over the past few weeks, pressure has steadily increased on DeMarco and the FHFA to make concessions on the issue. A coalition of 100 Congressional Democrats, including all of those on the Senate Committee on Banking, Housing and Urban Affairs have signed a letter urging the mortgage giants to do so. Principal reductions were also an important component of the recent settlement between five large lenders and the 50 states’ attorney generals – and Massachusetts Attorney General Martha Coakley used the occasion to urge Fannie and Freddie to take up the measure.
Perhaps most important, the Obama administration has offered to increase reimbursements to the GSEs under the Home Affordable Modification Program (HAMP) – but only if they allow principal reductions.
Last week in a speech at the Washington, D.C.-based Brookings Institute, DeMarco conceded that with increased HAMP payments, principal forgiveness would likely save the GSEs more money than a standard modification., the GSEs estimated they’d probably lose $63.7 billion on the pool of 691,008 loans across the country likely to be eligible for such modifications if they are not modified. They figured they would lose $55.5 billion with standard modifications and $53.7 billion with principal reduction – a $1.8 billion difference.
That admission has local bankers worried that the FHFA will soon change its tune – putting pressure on them to follow suit.
“It’s hard to know what the potential fallout could be on a broader scale, but any time you get one of these programs announced, you get people coming into local banks saying, ‘How can I get my loan reduced?’” said Jon Skarin, senior vice president for federal regulatory and legislative policy for the Massachusetts Bankers Association.
“Most of our member banks are very aggressive about contacting people in a default situation and trying to keep them in the property somehow,” Skarin continued. “There’s a whole range of tools available – principal reductions is one, but it’s not the only one. It may not make sense in every situation.”
Credit unions too, have spoken out against the proposal. Credit Union National Association (CUNA) President Bill Cheney wrote to DeMarco recently and said an FHFA principal forgiveness program could cause a “domino effect leading to strategic defaults outside of the body of mortgages backed by the Enterprises…potentially force[ing] a private lender into agreeing to forgive principal – even though such lender would technically not be subject to FHFA’s program.”
Every Bit Helps
And bankers’ fears regarding the potential impact of principal forgiveness on borrowers was echoed by many who work with homeowners already in default. Some said they were skeptical about how much principal reduction would help.
Tony Lopes, housing director for Agawam-based Cambridge Credit Counseling Corp., said that with HAMP modifications already tougher to obtain than private modifications – and many private lenders already using principal reduction in some circumstances – the pool of borrowers eligible may be small.
“On the counseling end we see a lot more approvals through in-house modifications as opposed to HAMP modifications,” he said. “When you factor in that 16 percent of current loans through HAMP use principle reduction, and only 25 percent of the current modifications are HAMP modifications, it would help only a small segment of distressed homeowners.”
But at the end of the day, Lopes continued, if the program tweaks allow even a small amount of homeowners to stay in their homes, it will help with the recovery of the housing market.
“If you look at your own mortgage, if you took say, $50,000 off, yeah that would help, but it’s not necessarily going to be that much [of an impact on monthly payments] over time,” said Philip Giffee, executive director of Neighborhood of Affordable Housing in East Boston, which counsels distressed borrowers. Packaged together with a rate reduction and other changes in loan terms, principal reduction might be useful, he said, but it may not do much by itself.
DeMarco won’t have to make a final decision on whether to allow principal forgiveness until the end of the month. And it’s possible he may hold firm – in the same speech, he took pains to point out that it wouldn’t take very many strategic defaulters to wipe out any possible savings from principal reduction.
