The big housing policy fight brewing between the Obama administration and the Federal Housing Finance Agency, the regulator that oversees Fannie Mae and Freddie Mac, is over principal forgiveness: lowering the burden of outstanding mortgage debt on homeowners in order to reduce foreclosures and get homeowners out from their underwater mortgages.
Nick Timiraos reports in the Wall Street Journal that the disagreement between the administration and the FHFA’s head, Edward DeMarco, over principal forgiveness is fully out in the open, especially since the Treasury has offered to put up some of the money for the write-downs. What’s interesting is that DeMarco’s argument against principal forgiveness, as explained in a recent speech, is a great argument for another ambitious housing policy — a large scale refinancing of the underwater mortgages backed by Fannie and Freddie:
The fundamental point of a loan modification is to adjust the borrower’s monthly payment to an affordable level. We have seen repeatedly that what matters most in successfully helping borrowers is a meaningful reduction in the monthly payment to an amount that helps stabilize the family’s finances. Indeed, we have found that payment reduction, not loan-to-value, is the key indicator of success in loan modifications.
Moreover, this approach recognizes that three out of every four deeply underwater borrowers in Fannie Mae’s and Freddie Mac’s book of business today are current on their loans. These borrowers are demonstrating a continued willingness to meet their mortgage obligations. This should be recognized and encouraged, not dampened with incentives for people to not continue paying.
So, if homeowners who are vastly underwater are still current on their payments and will likely be so in the future, then there is little reason to simply write-off their principal, which would end up increasing the liability of the taxpayer and would not actually be all that effective in preventing foreclosure. But if that’s really the case, then Fannie and Freddie ought to be doing a lot more to facilitate refinancing of these mortgages.
If underwater homeowners are able to stay current on their mortgage at an interest rate that is a few percentage points above the low prevailing ones — and 75% of Fannie and Freddie backed homeowners who are underwater are current — then there is little reason not to help those same homeowners refinance at lower rates. After all, they have demonstrated an ability to make the payments, so their inability to refinance due to a horrendous housing market that has lead to so many underwater mortgages is an inefficiency that can be ameliorated by the intervention of Fannie and Freddie.
In the same speech where DeMarco criticizes principal forgiveness, he lauds the HARP program, which facilitates refinancing for underwater mortgages and was recently extended and its eligibility criteria relaxed. It has, however, only successfully refinanced around one million mortgages. In any case, the FHFA only expanded HARP after the White House and many outside analysts had been calling for mass refinancing for almost two years, and most refinancing advocates still think that Fannie and Freddie could do much more. Whether the FHFA will follow the logic of its administrator, of course, remains to be seen.