WASHINGTON — With the overseers of Fannie Mae and Freddie Mac digging in their heels against the use of principal write-downs for troubled homeowners, Senate Democrats pressed their case for a course change on Thursday.
At a hearing of the Senate housing subcommittee, Democratic Sen. Robert Menendez of New Jersey highlighted private-sector firms that have embraced the use of principal reduction in certain circumstances. He drew a contrast between the private sector and the Federal Housing Finance Agency, which oversees Fannie and Freddie and does not grant such write-downs.
"I would note that private banks are finding it more profitable than other methods of mortgage modifications to do principal reductions on about 20% of their own portfolio loans, and yet the government is not even allowing principal reduction on any of its loans, completely removing that tool from the toolbox," Menendez said.
The FHFA did not testify at the hearing, but its acting director, Edward DeMarco,
Thursday's hearing came amid increasing pressure on the FHFA from the Obama administration and Democrats on Capitol Hill. Last week, several members of the Congressional Progressive Caucus
Among those testifying at Thursday's hearing was John DiIorio, chief executive officer of 1st Alliance Lending, a firm that specializes in mortgage modifications involving principal write-downs.
"An often overlooked fact is that principal reduction, done correctly and in a targeted manner, is sometimes the best economic option for the holder of the mortgage," DiIorio stated in written testimony, "and often significantly enhances the value of the asset. In fact, we increasingly see holders of underwater mortgages utilizing principal reduction as part of their asset maximization efforts. These are sophisticated counterparties, acting in their own financial interest."
Also testifying was Laurie Goodman, senior managing director at Amherst Securities, who said that her research has shown that principal write-downs are the most effective form of mortgage modification.
Goodman was critical of the way that the FHFA conducted its analysis of the cost of a principal reduction strategy. She noted, for example, that the agency used a hypothetical model rather than relying on actual data from modifications that use principal write-downs.
She also confronted the primary objection to such write-downs, which is the argument that many homeowners will voluntarily default on their mortgages in order to get a break on what they owe.
"It is possible to structure a principal reduction program to minimize the moral hazard issue," Goodman stated.
In particular, she said that a principal reduction program can be structured to allow only homeowners who are delinquent at the start of the program. She also endorsed an idea, which Menendez is proposing in legislation, to allow Fannie and Freddie to share in future gains in the value of a home in cases where the borrower gets a principal write-down.
Offering a much more skeptical view was Mark Calabria, director of financial regulation studies at the Cato Institute. He argued that the FHFA does not have the statutory authority necessary to implement a principal reduction program.
"Acting FHFA Director DeMarco should be commended for his faithfulness to the letter of the law," Calabria said in written testimony. "To suggest this action be implemented without Congressional approval would only further erode the already diluted powers of Congress relative to the other branches of government."
