Fannie and Freddie: Slashing Mortgages Is Good Business
By Jesse Eisinger, ProPublica  
Chris Arnold, NPR
March 23,2012
http://www.propublica.org/article/fannie-and-freddie-slashing-mortgages-is-good-business

	Update: On Friday, following the publication of
	this story by ProPublica and NPR, lawmakers
	called on the Federal Housing Finance
	Administration to provide Congress with the new
	analyses on principal reductions by Fannie Mae
	and Freddie Mac. In addition, Illinois Attorney
	General Lisa Madigan urged FHFA to immediately
	implement appropriate principal reductions to
	home loans held by Fannie Mae and Freddie Mac.

	A version of this story was co-published with
	NPR News and broadcast on NPR's Morning Edition.

New analyses by mortgage giants Freddie Mac and Fannie
Mae have added an explosive new dimension to one of the
most politically charged debates about the housing
crisis: Whether to reduce the amount of money
beleaguered homeowners owe on their mortgages.

Their conclusion: Such loan forgiveness wouldn't just
help keep hundreds of thousands of families in their
homes, it would also save Freddie and Fannie money.
That, in turn, would help taxpayers, who bailed out the
companies at a cost of more than $150 billion and are
still on the hook for future losses.

The analyses, which have not been made public, were
recently presented to the agency that controls the
companies, the Federal Housing Finance Agency, according
to two people familiar with the matter. Freddie Mac's
meeting with the FHFA took place last week.

The decision of whether to allow such reductions rests
with Edward DeMarco, the acting director of the FHFA,
who has steadfastly opposed so-called principal
reductions on the grounds that it's a bad business
decision for the companies and would cost taxpayers
money.

Many economists and policy makers contend that cutting
principal - the amount of money lent to the homeowner -
is one of the best solutions for keeping people in their
homes and to bolster the fragile economic recovery.

But this solution has raised passionate opposition: Many
borrowers who are paying their mortgages every month
feel it is unfair. Why, they ask, should they have to
keep paying the full amount while others who took a loan
they ultimately couldn't afford or saw their house
plummet in value get a break? Some economists and policy
makers argue that borrowers might intentionally stop
paying their mortgages to score a reduction. Indeed, the
prospect that the government would help troubled
homeowners was a spark that created the Tea Party
movement.

The companies' new analyses were prompted by new Obama
administration subsidies the government is offering
Fannie and Freddie to reduce a homeowner's loan. But
it's unclear whether DeMarco will take advantage of
those incentives.

He declined to be interviewed for this story. But in a
statement to ProPublica and NPR, DeMarco said that FHFA
is assessing its position in light of the new Obama
financial incentives, offered under the Home Affordable
Modification Program, or HAMP. "As I have stated
previously, FHFA is considering HAMP incentives for
principal reduction and we have been having discussions
with [Freddie and Fannie] and Treasury regarding our
analysis."

Both Fannie and Freddie declined to comment.

As an independent regulator, DeMarco does not answer to
the president and can make policies that the
administration opposes. Obama sought to replace DeMarco,
but his nominee was blocked by Republicans in the
Senate, which must confirm the agency head.

As recently as Feb. 28th, DeMarco told the Senate
banking committee, "Both companies have been reviewing
principal forgiveness alternatives. Both have advised me
that they do not believe it is in the best interest of
the companies to do so."

Overall, principal reductions could help millions of
borrowers who owe much more on their homes than their
houses are worth, economists estimate.

And principal reductions can help lenders, because
foreclosure often leads to bigger losses than reducing
the amount owed. The biggest banks have long employed
such reductions to curb their own losses.

The new analyses by Freddie and Fannie were done to
assess the new financial incentives that the Obama
administration announced in late January. ProPublica and
NPR have not read the analyses, but two people described
key aspects of them. The companies now find that
reducing principal on troubled mortgages has a "positive
net present value" - in other words, that doing it would
bring in more money for the companies over the life of
the loans than not doing it.

The two companies' analyses showed that upwards of a
quarter million borrowers who owe more on their
mortgages than their homes are worth could benefit from
principal reductions. The companies would take a loss
upfront, but over the long run these mortgage
modifications would save the companies money because
they would lead to lower default rates.

Experts have said that principal reductions are one of
the best tools for helping homeowners stay in their
homes.

"Principal reduction works," said Mark Zandi, chief
economist of Moody's Analytics. "If someone gets a
reduction in their principal amount, it gives them a
real powerful hook to really fight to try to hold onto
the home, even if things aren't going financially right
for them."

The re-default rate for homeowners who receive a
principal reduction is lower compared with the rate on
other types of types of mortgage modifications, Zandi
said.

Zandi estimates that principal modification could
benefit 300,000 to 500,000 homeowners whose mortgages
were backed by Fannie and Freddie. "And that would make
a substantive difference," he says, in helping the
housing market and boosting the economy.

"It saves taxpayers money and makes homeowners less
likely to default," said Zandi. Given the Obama
Administration's policy changes, "I'm now perplexed why
DeMarco is not more fully engaged" in supporting
principal reductions.

Not everyone supports principal modifications. Anthony
Sanders at George Mason University says that
implementing such reductions risks triggering a wave of
strategic defaults, where people stop paying on their
homes in order to qualify for a break. "DeMarco is
absolutely right," he says.

The Obama administration's new initiative triples the
subsidies. They now range from 18 cents to 63 cents on
the dollar, based on conditions such as how deeply
underwater a borrower is. The subsidy works out so that
generally the Treasury would pick up about half of
Freddie and Fannie's principal reductions, according to
a person familiar with the incentives.

The subsidies are funded through HAMP, which used money
from the Troubled Asset Relief Program (TARP), widely
known as the bank bailout.  Much of that money has not
been spent.

Under DeMarco, the FHFA has allowed Fannie and Freddie
to do principal forbearance, rather than principal
reductions. In such a modification, borrowers' monthly
payments are reduced, but they still must eventually pay
back the entire loan. Critics contend that such
modifications don't provide as much incentive as
principal reductions for borrowers to keep paying.

Despite the new findings, it still might not make sense
for Fannie and Freddie to do principal reductions. Such
a program might require substantial and expensive
changes to their computer and accounting systems and
might distract from the core business. In his statement,
DeMarco said, "FHFA's previously released analysis
concluded that principal forgiveness did not provide
benefits that were greater than principal forbearance as
a loss mitigation tool. FHFA's assessment of the
investor incentives now being offered will follow the
previous evaluation, including consideration of the
eligible universe, operational costs to implement such
changes, and potential borrower incentive effects."

Yet even before the Obama administration's new
subsidies, the FHFA's own data supported principal
reductions for some borrowers, despite its opposition to
using them, some argued. An American Banker analysis of
the FHFA study, which the agency sent to Congress in
January, suggested that principal reduction shouldn't be
rejected so unequivocally.

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