In a speech to the New Jersey Bankers Association Economic Forum in Newark, New York Fed President William Dudley called for Fannie Mae and Freddie Mac to enact a form of principal writedowns on mortgages in order to help the housing market recover.
We’ve discussed the problems in the housing sector ad nauseum, but it they are worth briefly recapping. Home prices are down by about a third on average since 2006. There are 1.5 million mortgage that are at least 90 days delinquent, and another 2 million in some stage of foreclosure. There is a massive overhang of housing supply both on the market and in shadow inventory, and there is a dearth of demand for housing due to unemployment, economic uncertainty, and lack of household formation. This imbalance in supply and demand is still causing home prices to fall. Additionally, nearly 11 million homes with mortgages have negative equity, which accounts for about 22 percent of all homes with mortgages. There is about $700 billion worth of negative equity in the housing market. Dudley says that
“Persistent weakness in housing is particularly problematic because it acts as a drag on spending and job creation in an environment in which such weakness can not be easily offest by other policy adjustments. Housing policy should seek to break adverse feedback loops [Dudley is referring to the way that price declines lead to foreclosure, which in turn drives more price declines, which leads to more foreclosure], promote more economically efficient outcomes in housing, and support growth”.
In order to help the housing market, Dudley calls for “improved access to mortgage credit, reduced obstacles to refinancing, lessening the flow of homes into foreclosure through bridge financing and accelerated principal reduction, and facilitating the absorption of REO back into use as owner- or renter- housing”. The proposals for improving access to credit and turning REO into rentals are fairly straight forward. More interesting to me is the proposal for what Dudley calls “earned principal reduction”. Dudley proposes:
“I believe we should also develop a program for earned principal reduction for borrowers who are underwater but keep on making their mortgage payments. Such a program would strengthen the incentives for mortgage holders who are underwater to continue to stay current on their loans, and reduce the likely number of defaults and REO sales.
One option developed by my staff is for Fannie Mae and Freddie Mac to give underwater borrowers on loans that they have guaranteed the right to pay off the loan at below par in the future under certain circumstances, including that the borrowers have continued to make timely payments.
The borrower would be protected from further declines in home prices, but in return would give up a portion of any upside from future capital gains on the home via a shared appreciation agreement”.
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