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Is DeMarco Ready to Write Down Mortgages? | The Nation

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George Zornick

George Zornick

Action and dysfunction in the Beltway swamp. E-mail tips to george@thenation.com

Is DeMarco Ready to Write Down Mortgages?

Progressives have mounted an increasingly intense campaign to pressure Edward DeMarco, acting director of the Federal Housing Finance Agency, to write down the principal on mortgages held by Fannie Mae and Freddie Mac. The FHFA took control of Fannie and Freddie during the 2008 crisis, and DeMarco has since prohibited the two companies from reducing principal amounts of troubled mortgages, citing concerns that it would hurt the Fannie and Freddie bottom lines.

But in a speech at the Brookings Institute today, DeMarco opened the door—a little. “I will not be announcing any conclusions today,” he said, but talked of the potential that “Fannie Mae and Freddie Mac might apply principal forgiveness.” That’s at least not a firm no, which is what DeMarco had previously offered.

It’s important first to flag this as a (small) progressive victory—it’s hard not to draw a line from the Congressional and progressive pressure to today’s speech, in which DeMarco not only doesn’t rule out principal reductions, but speaks forthrightly to the human cost of the housing crisis:

Throughout this crisis each of us know of, or have heard about, many individual stories of homes lost through foreclosure. One cannot help but have sympathy for those who have suffered such misfortune. And surely no one can look at the dislocations in the housing market and not feel frustration at how so many people and institutions failed us, whether through incompetence, indifference, or outright greed or fraud. Yet we are also blessed in this country with people and institutions who care, who are strongly motivated to provide assistance and find solutions. […]

Six years into this housing downturn, the losses persist. The debate continues about how we as a society are going to allocate the losses that remain. Asking hard questions in this debate does not make one unfeeling about the personal plight this situation has created for so many. Indeed, the majority of those most hurt by this housing crisis did nothing wrong – they were playing by the rules but they have been the victims of timing or circumstance or poor judgment.

DeMarco’s potential shift here is based on a FHFA study of how updates to Treasury’s HAMP program might help the agency write down severely troubled mortgages—an analysis that found FHFA could realize $1.7 billion in savings by forgiving principal on some loans.

The agency examined a pool of 700,000 mortgages, on which Fannie and Freddie would lose an estimated $63.7 billion if they were not modified. The analysis looks at the recently tripled incentives under HAMP for principal write-downs, and finds that the losses would be $53.7 billion if some principal were forgiven, while the losses would be $55.7 billion if those loans were granted forbearance—this means some principal isn’t reduced, but taken off temporarily until payments can be made. This is the method DeMarco has heretofore preferred, but this analysis shows it might be more costly than principal reduction—and this is significant. After factoring in the money sent over from Treasury and the people who may redefault, the analysis found $1.7 billion in savings for FHFA under principal reduction.

DeMarco is focusing on, at most, 1 million homeowners, which is but a small slice of the troubled mortgages held by Fannie and Freddie—they have about 60 percent of the market. Why such a small segment? That’s what some Democrats already want to know.

“[W]ith millions of homeowners facing foreclosure, principal reduction for less than a million homeowners is no silver bullet,” said Senator Jeff Merkley of Oregon today. “We moved mountains saving the major financial institutions in 2008 and 2009. It’s now time to bring the same energy and conviction to restore health to our housing market and help families stay in their homes.” (He also noted that DeMarco’s speech was a “step in the right direction.”)

In any case, let’s look at the rest of DeMarco’s speech. While he is opening the door to principal write-downs, he does outline several policy reasons why he thinks they might not work, or might not be desirable. He focuses in particular in two possibilities for moral hazard.

The first is the potential for homeowners to enter “strategic default”—in other words, to stop making payments until they are troubled enough to receive a principal write-down. DeMarco estimated that it would only take 20,000 strategic defaulters to wipe out the $1.7 billion savings.

This is a popular Republican talking point, but in fact little moral hazard really exists here. Throughout the housing crisis strategic has been simply a boogeyman—nobody can find actual evidence that people are actually engaging in it en masse. And when it comes to the homeowners in the GSE portfolio, very few are even in a position where it would make sense to do so, and everyone else shouldn’t suffer for it. This is a point highlighted by Housing Secretary Shaun Donovan earlier this week. “We shouldn't punish the vast majority of folks where strategic default isn't really a risk just to fix what may be a risk with a small percentage (of borrowers),” he said.

The other moral hazard DeMarco outlines is more real—he argues that principal write-downs could basically be a second bailout to big banks, and essentially reward previous misdeeds.

Here’s the argument: many homeowners—as much as 50 percent of those under Fannie and Freddie, DeMarco estimates—have a second lien on their home with a third party, probably a big financial institution. When Fannie and Freddie write down the principal—a hit to taxpayers, especially considering the Treasury incentives—the big bank holding the second lien benefits, because, though it has written nothing down, it shares in the benefit of a homeowner now more able to make payments. This is especially true if there’s still a foreclosure anyhow.

Under HAMP, there is a Second Lien Modification Program, but as DeMarco noted, that’s still problematic—under that program, the first and second lien holders share in losses. Normally, the first lien holder would not have to share in these losses.

The problem of second liens is one that deserves a thoughtful policy response. But in any case, it’s a bit odd to hear DeMarco suddenly making an argument about the impropriety of helping big banks' bottom lines, when his position so far has simply been to protect "his" banks’ bottom lines. One wonders if perhaps DeMarco is still searching for reasons not to issue write-downs—but it’s clear he’s feeling the pressure.  

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