A home under threat of foreclosure in San Antonio, Monday, February 23, 2009. (AP Photo/Eric Gay)

The crucial context to President Obama’s nomination of Representative Mel Watt to head the Federal Housing Finance Agency is principal reduction for distressed homeowners: in other words, a policy to reduce what some people with underwater mortgages owe.

FHFA controls Fannie Mae and Freddie Mac, which in turn holds 60 percent of the mortgages in the United States. The Congressional Budget Office estimated last month that if the FHFA director ordered even a modest write-down of the underwater mortgages held by Fannie and Freddie, 1.2 million borrowers could benefit—and, the government would save $2.8 billion and avoid 43,000 defaults.

FHFA’s current director, Edward DeMarco, has refused to enact this policy—leading to a progressive “Dump DeMarco” campaign. The administration presumably had this in mind when it nominated Watt—who has backed principal reduction strongly in the past—to take DeMarco’s job. (Obama’s Treasury Department agrees that write-downs should happen.)

So, naturally this all came up in Thursday’s Senate Banking Committee confirmation hearing for Watt and four other financial regulatory nominees. Senator Pat Toomey pressed Watt to pre-emptively declare he would not engage in any write-downs.

Watt, to his credit, did not agree—but he also didn’t endorse the policy, and said some potentially troubling things about its supposed necessity.

It’s worth reproducing the exchange nearly in full, as it was the only time principal reduction came up.

TOOMEY: Are you prepared to commit, now, that you will not implement principal reductions on mortgages?

WATT: …I suspect I will be asked to look at that again because some people will still think it’s a relevant question, despite the fact that housing prices have gone up and there are fewer and fewer people underwater at this point than there have been.

But I would start, as I would with any issue that has been decided already by FHFA, I would start by studying carefully how that decision was reached, what it was based on, and then I would build on that new information—the information on which that decision was made is a year and a half old now—and make a responsible decision.

So Watt is pledging to revisit the issue and won’t agree to rule out principal reduction—that’s good. But his suggestion that it may no longer be “relevant” is slightly troubling—there millions of Americans still underwater, including over a million with mortgages at Fannie and Freddie that are either already delinquent or headed that way.

Toomey jumped back in here, and tried to pin Watt down by noting he signed a letter in December demanding DeMarco enact principal reduction.

TOOMEY: The concern is that the information was quite recent, but available, when you signed a letter in December, urging exactly this principal reduction despite the fact that FHFA analysis [said] that this was not a good idea—was not a good idea for the enterprises, wasn’t a good idea for the taxpayers, and I don’t think it’s a good idea for mortgage credit availability generally. And so the concern is that based on the data then, and the analysis then, that suggested this was a bad idea, you nevertheless recommended it. So that’s why I’m wondering how we should view this now.

Note that Toomey is wrong here—the FHFA analysis didn’t quite say that, or at least the parts it didn’t release publicly didn’t say that. Also, there’s that recent CBO report saying the opposite, along with a raft of similar outside studies.

Watt immediately noted that—but then went on to almost disclaim the letter demanding principal reduction.

WATT: First of all, there was conflicting data out there. Obviously FHFA had made a decision that reached one conclusion, but there was conflicting data.

Second of all, you’ve got to understand that I was a member of Congress representing my constituents, many of whom were underwater and advocating for relief for them. You should have no doubt that I will be a strong and aggressive advocate for the taxpayers in this role, because I view them as my constituents in this role, not the constituents that I represented before.

What’s potentially troubling here is that “I’m looking out for the taxpayers, not homeowners” was DeMarco’s mantra when he declined to enact principal reduction.

That said, Watt is correct—if not inspiring—in describing his new constituency as potential FHFA head. And of course one must remember the context here: a tough confirmation process. Republican Senators Bob Corker and Mike Crapo both appeared to be opposed to Watt’s nomination during the hearing. (At one point, Senator Elizabeth Warren said “If I could, I’d vote for Congressman Watt twice.” Watt deadpanned: “You might need to do that.”)

So should reformers be concerned about Watt’s answers?

“That’s what we expected,” said Tracy Van Slyke, director of New Bottom Line, about Watt’s careful comments around principal reduction. “He’s not the head of FHFA yet. He needs to get in there…. We understand this is a confirmation hearing.” She added that his past support of principal reduction “set the tone that he’s going into FHFA with a much more open mind.”

Van Slyke added that her group would continue to pressure Watt if he’s concerned to make sure principal reduction is done, and done “the right way.”

But she did acknowledge his answer that seemed to downplay its necessity was a little worrisome. “I think that’s some education that still needs to happen,” she said. “We know that right now the housing recovery, the so-called housing recovery, is actually benefiting the corporations and banks that profited off the first housing bubble.”

George Zornick laments the long road towards justice for homeowners.