May 2, 2012 by Leave a comment

There were some interesting developments over the past two days regarding the ongoing battle over mortgage principal reductions. In a letter dated May 1, Representatives Elijah Cummings (D-MD) John Tierney (D-MA) alleged that federal regulators withheld analysis from Congress showing that principal reductions could curtail losses from mortgage defaults.  In a letter to Ed DeMarco, head of the Federal Housing Finance Agency (FHFA), the conservator for Fannie Mae and Freddie Mac, the congressmen alleged:

“Contrary to your testimony, we have now obtained a wide range of internal documents demonstrating that Fannie Mae officials conducted detailed, substantive analyses and concluded years ago that principal reduction programs have enormous potential to save U.S. taxpayers significant amounts of money by reducing overall losses from foreclosures fol lowing default. Although we recently obtained some of these documents directly from you in response to our request last November, we obtained from an independent source several additional documents that are labeled “confidential,” “proprietary,” and “internal,” and that you apparently have been withholding from Congress”.

The Congressmen claim that Fannie Mae supported a “shared equity” principal reduction program that was terminated “for unspecified reasons.”  Later in the letter, it is stated that “a former Fannie Mae employee has informed us that the program was terminated by officials who were ‘philosophically opposed to writing down principal balances.'”  It is also claimed that an internal Fannie Mae presentation showed that re-default rates on modifications that included principal reductions were better than those which did not, and that the “shared equity” model of principal reduction reduced the risk of moral hazard.

DeMarco quickly responded to the Congressmen with a letter of his own, dated May 1.  DeMarco took umbrage at the accusations

“I wish to convey my disappointment with this letter, the failure to contact FHFA to address your concerns, and the release of selective elements of the proprietary and confidential materials your recieved…I strongly disagree with any characterization of FHFA’s work on motives as anything but in keeping with the professionalism expected of this agency.”

DeMarco also claimed that: “the fact that FHFA continues to consider principal forgiveness alternatives, including recent HAMP program changes initiated by the Treasury Department, belies any ideological tilt on our part.”

So where does the truth lie in this pissing contest over principal reduction?  As always, it probably is somewhere between the two sides.  There is little question in my mind that the Congressmen are politically motivated (even if they are on the right side of this issue).  I don’t know where DeMarco’s motivations lie.  He is a lifelong government regulator who has been placed in an extremely difficult position.  DeMarco did say that there is a risk of “moral hazard” associated with principal reductions plans – and he is probably right to a degree.  My issue with the moral hazard argument is that it would be a much stronger, more consistent argument had we not bailed out the too-big-to-fail banks, essentially backstopping their risky gambles – what’s good for the goose is good for the gander.

Here’s another thing about this debate: the numbers that we are seeing bandied about are far too small to really do much .  The brutally awful mortgage settlement may include up to $10 billion in principal reduction – a drop in the bucket compared to the more than $700 billion in negative equity spread across the housing market.  The numbers in the documents cited by Tierney and Cummings claimed that a pilot principal reduction program would cost $1.7 million and generate $410 million in savings (it doesn’t specify exactly how much principal would be written down).  If the pilot program were successful, presumably it would be expanded, but those details are scant.

At the end of the day, all this sturm and drang is over a program that even if implemented, would likely be far too small to effect any real change on the housing market.  That is what annoys me about this debate more than anything.  We have no real housing policy in the United States (seriously – I defy you to put pen to paper and define the goals of U.S. housing policy and how we plan to dig out of the hole in which we find ourselves – check out this article from Georgetown Law Professor Adam Levitin on this debacle).  Our lawmakers/regulators are bickering over programs and plans that at best will help on the margins, meanwhile home values continue to spiral downwards and foreclosures continue.


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