WASHINGTON — Although Edward DeMarco, the acting director of the Federal Housing Finance Agency, did not officially decide whether to allow Fannie Mae and Freddie Mac to pursue a broad principal forgiveness program, his remarks Tuesday left little doubt he will ultimately reject such an approach.
Offering one of the most explicit arguments to date, DeMarco outlined the drawbacks of principal reductions and considerations the agency would need to weigh before allowing Fannie and Freddie to engage in principal reductions.
"This is not about some huge difference-making program that will rescue the housing market," said DeMarco, in a speech before the Brookings Institute, a non-partisan think tank. "It is a debate about which tools, at the margin, better balance two goals: maximizing assistance to several hundred thousand homeowners while minimizing further cost to all other homeowners and taxpayers."
Industry observers said the speech made it clear which way DeMarco was leaning.
"We see this as a strong political attack against principal reduction," wrote Jaret Seiberg, a senior policy analyst for Guggenheim's Washington Research Group, in a note to clients.
Principal reduction has emerged as a crucial issue in efforts to work out troubled loans threatened by foreclosure. An array of experts and officials have cited research showing write-downs as perhaps the only broad-based way to resolve bad credits short of mass foreclosures. But the government-sponsored enterprises, as well as others in the industry, have resisted such reductions. DeMarco has repeatedly been on the defense over the agency's reticence to move ahead on principal forgiveness and agreed in January to take a second look at the government's Home Affordable Modification program after it began offering triple incentives to investors who used the program.
"FHFA is still in the process of analyzing whether the enterprises will offer principal forgiveness as part of HAMP with the triple incentives provided by Treasury," said DeMarco. "Our work is not yet complete."
DeMarco said he expects a final answer in the next few weeks, but offered some preliminary findings that updated the agency's earlier analysis and made changes to its modeling work based on various criticisms.
For example, the FHFA lowered delinquent borrowers FICO scores by 100 points. It also raised those borrowers' housing payment debt-to-income ratio and applied zip-code level rather than state-level Home Price Indexes to update current loan-to-value ratios.
According to data provided by the agency, losses to the enterprises on these loans if left unmodified are estimated to be $63.7 billion. Losses would decline to $55.5 billion if Fannie and Freddie allowed principal forbearance, and fall even further if principal forgiveness was allowed, to $53.7 billion. In short, by using the triple incentive program, Fannie and Freddie would see their losses reduced by an extra $1.7 billion.
While that sounds like good news for Fannie and Freddie, it's not necessarily positive for taxpayers, DeMarco warned.
Those incentive payments would cost Treasury, and thus taxpayers, roughly $3.8 billion. As a result, DeMarco said the net cost to the taxpayer, including savings from Fannie and Freddie and added payments from Treasury, would be $2.1 billion.
That is not the only factor that needs to be considered, DeMarco said. Two others include borrower incentive effects as well as operational costs.
"As FHFA makes it decision on whether the enterprises should offer principal forgiveness with the HAMP triple incentives, we will look to the issues I have described: the net present value impact; borrower incentive effects; and operational costs," said DeMarco.
That would include the indirect costs of launching a new program as well as guidance to and training for mortgage servicers.
DeMarco also raised serious doubts that the triple incentive program would be the silver bullet that could help millions of borrowers, as some have suggested.
"Whether Fannie Mae or Freddie Mac forgive principal or not, the universe of enterprise borrowers potentially eligible for a HAMP principal reduction alternative is well less than one million households, a fraction of the estimated 11 million underwater borrowers in the country today," said DeMarco.
DeMarco sought to make a comparison between principal forbearance and principal forgiveness to help send his point home.
"At the most basic level, the comparison between the loss mitigation strategies of principal forbearance and principal forgiveness is related to who gets the upside," said DeMarco.
In both cases, if a borrower were to default, Fannie and Freddie would lose the same amount. However, if a borrower is able to successfully pay on their loans, after a principal forbearance modification, the enterprises would retain an upside to the forborn amount. Under principal forgiveness, the borrower would retain the upside.
"The anticipated benefit of principal forgiveness is that, by reducing foreclosures relative to other modification types, enterprise losses would be lowered and house prices would stabilize faster, thereby producing broader benefits to all market participants," said DeMarco.
Instead, the emphasis should be placed on encouraging borrowers who have kept making monthly payments on time even as they've seen their homes values slip underwater.
"Encouraging their continued success could have a greater impact on the ultimate recovery of housing markets and cost to the taxpayers than the debate over which modification approach offered to troubled borrowers is preferable," said DeMarco.