Fannie and Freddie, penny wise and pound foolish?
Edward J. DeMarco, the federal regulator overseeing Fannie Mae and Freddie Mac, isn't known for moving quickly in response to the foreclosure crisis. But he wasted no time answering California Atty. Gen. Kamala Harris' request that Fannie and Freddie suspend foreclosures in this state until his office completes a "thorough, transparent analysis" of mortgage modifications based on partial debt write-downs.
On Monday, the next business day after Harris sent her letter, DeMarco gave her the thumbs down. His response, which Harris' office released Wednesday, contended that numerous foreclosure delays and moratoriums "have already taken place, each adding to the losses shifted to American taxpayers and further destabilizing neighborhoods." He went on to argue that Fannie and Freddie's foreclosure-avoidance efforts have allowed more than 85% of the borrowers helped to keep their homes.
Yes, but for how long?
The issue isn't how many troubled borrowers have their loans modified. The issue is how many of those loans end up costing Fannie and Freddie -- and by extension, the taxpayers who are absorbing their losses -- more than they would have had the companies written off part of the borrower's debt. That's a function of the cost of the modification plus any losses incurred when borrowers default on their modified loans.
Data from 2010 that DeMarco furnished Congress show that re-default rates declined the more a borrower's monthly payment was reduced, regardless of how deeply underwater a borrower happened to be. But those were re-default rates nine months after a modification. It stands to reason that those rates will go up over time for borrowers who owe far more on their loans than their houses are worth, mainly because the debt overhang prevents them from selling the house should they need to move.
Putting Harris' support for principal write-downs in the least flattering light, DeMarco wrote, "There is no question that underwater borrowers in California would benefit from other taxpayers across the United States paying off the underwater portion of their mortgage debt." Nor is there any question that taxpayers across the United States would benefit from loan modifications in California that prevent Fannie and Freddie from losing even more money than they already are.
Among the projections that DeMarco sent to Congress was one showing that principal write-downs could cut Fannie and Freddie's losses dramatically if the companies servicing the loans picked up part of the up-front cost. And that's just one of the possibilities for mitigating the short-term hit that write-downs would impose on Fannie and Freddie.
Striking his most dismissive note, DeMarco said there was no need to think further about the merits of principal write-downs. The Federal Housing Finance Agency, where he serves as acting director, has already done three analyses. What he didn't say was that those analyses were based on financial models, not real-world experience. That's what Harris wants him to look at, starting with the write-downs that five major banks have agreed to do to settle the "robo-signing" probe launched by state attorneys general.
The real challenge with a write-down program is how not to induce defaults by people who aren't in financial distress -- the "moral hazard" problem. That's a different issue from the ones DeMarco raised in his letters to Congress and Harris. The problem can be minimized by restricting aid to borrowers with demonstrable financial hardships (for example, those whose pay has been slashed or who've been hit with huge medical bills). Granted, that may not mollify borrowers who get no relief because they've stayed out of financial trouble. The question for those homeowners is whether they'd rather shoulder more losses at Fannie and Freddie, as well as more damage to property values and more blight, than see Fannie and Freddie help some of their neighbors.
-- Jon Healey
Photo: Edward J. DeMarco, FHFA acting director, testifies before the Senate Banking Committee. Credit: T.J. Kirkpatrick / Bloomberg