Here’s a neat little exchange between Rep. John Tierney (D-MA) and Ed DeMarco, the head of the Federal Housing Finance Agency, that took place this morning at a House Oversight Committee hearing. Tierney asks DeMarco why FHFA, the overseer for Fannie and Freddie, has been so resistant to principal reductions. Tierney cites a few experts in the field (Neil Barofsky, Alan Blinder) who have advocated principal reductions, and then lays out the mathematics. The data indicates that in a foreclosure sale, the owner loses roughly 45% on the value of the home. “You’re going to lose 45% on a foreclosed property,” Tierney says. “If that’s the case, but you’re only going to lose 5% with a principal reduction program, why not reduce the principal?” I don’t know quite where 5% is coming from – principal reductions have to be bigger than that to have an impact – but Tierney could be referencing a write-down to 95% of market value, relative to getting much less than market value on a foreclosure sale. And in any respect, it’s true that a principal reduction over time will be much cheaper than allowing a home to go into foreclosure. And principal mods are the most durable types of loan modifications, the ones most likely to keep people in homes.
DeMarco responds that he’s done the math, and that “We’ve determined that principal reduction will not be the least-cost approach for the taxpayer to allow this homeowner an opportunity to stay in their home.” He alludes to principal forbearance, where a couple payments are temporarily forgiven, or the interest is forgiven, but the underlying debt still remains. DeMarco concludes, “I don’t believe I’ve been appropriated taxpayer funds to provide general support to the housing market.”
Tierney is incredulous. “But you have been empowered to maximize the value of the taxpayer’s assets. and if it’s less costly to modify the loan than it is to go to foreclosure, I would think that would break that fiduciary responsibility.” He cites other banks who are doing principal reductions (albeit not many; 73,000 in all of 2009 and 2010, when millions of homeowners are underwater). He references a program from Ocwen for shared appreciation modifications, where the bank writes down the loan to 95% of market value, and then takes 25% of the upside on a sale if the value of the home appreciates. “They’re not doing that to be nice. It’s in their financial self-interest.”
DeMarco just stonewalls him. “The decisions that we’ve made are consistent with our statutory mandate.” Tierney asks him to provide him with documentation to show him in the statute where FHFA principal reductions are forbidden.
The answer is that they’re not. Principal reductions would show a short-term loss in the value of the taxpayer portfolio, but would make financial sense over time. DeMarco resists because he wants to show immediate results on the balance sheet, and because shortsighted thinking has characterized the entire foreclosure crisis. Just today, Rep. Elijah Cummings (D-MD) released an inspector general report that shows Fannie Mae and Freddie Mac charged penalties to their participating servicers – for $150 million – because they weren’t foreclosing fast enough. In this sense, FHFA has the same exact point of view as the banks – liquidate housing, let the market “clear,” foreclose swiftly and without prejudice. And they penalized their servicers which couldn’t get the job done.
FHFA has now put together its new guidelines for HARP, the refinancing program. But that’s more of a stimulus measure than a fix for the housing market. FHFA continues to resist the principal mods that would represent the actual fix. They would rather see homeowners suffer quickly than help them survive.
UPDATE: Felix Salmon is really good on this today. Here, he games out what DeMarco is really trying to say:
“We’re keeping millions of underwater mortgages on our books at par. We know they’re not worth 100 cents on the dollar, and so do you. But our accounting conventions allow us to pretend that they are worth that much, and as a result we’re managing to kid ourselves that our assets are worth a lot more than they really are. If we modify the loans while keeping the principal amounts constant, we can continue to carry those loans on our books at par. But if we do principal reductions, the accounting conventions finally grow some teeth, and we’re forced to take a write-down. Since we don’t want to recognize reality and take that write-down, we’re simply going to avoid doing principal reductions instead.”