Wednesday, April 11, 2012

DeMarco signals new openness to principal reductions, but is focused on the numbers

by Sarah Jawaid and Ethan Handelman, National Housing Conference

FHFA Acting Director Edward DeMarco shared preliminarily analysis that principal reductions could save the GSEs $9.9 billion, which is $1.7 billion more than savings from existing principal forbearance policy, in part due to increased HAMP incentive payments from the Treasury. Speaking at the Brookings Institution April 10, DeMarco bluntly stated he was not yet ready to announce a decision on whether to encourage principal reductions, but he laid out the results calculated thus far. In his remarks, DeMarco also:
  • Offered more detail on principal forbearance. Currently, Fannie Mae and Freddie Mac have several tools available to help struggling borrowers—interest rate reduction, term extension, and principal forbearance. DeMarco’s remarks offer more detail about what terms and constraints apply to principal forbearance, which sets aside a portion of principal and requires no payments and accrues no interest on it for a period of time. This can make a significant difference in reducing a too-high monthly payment, but unlike a shared-appreciation modification, principal forbearance does not provide much renewed hope that deeply underwater borrowers can get their heads above water. Were the GSEs to make their policies on the back end clearer (what could be approved as short sales or whether they would pursue deficiency judgments, for instance), there might be more to motivate deeply underwater borrowers.
  • Highlighted concern about borrower response. DeMarco, in essence, stated that the GSEs' large market presence means policy changes on principal reduction are more visible, have to be more standardized, and may be more likely to trigger changes in borrower behavior. He did not discuss specific figures on likelihood of strategic default, but focused rather on simple calculations of to compare cost of strategic defaults to savings generated.
  • Noted operational costs of modification programs. Modifying lots of mortgages requires systems, and DeMarco described the costs of changing those systems as "nontrivial." Operational costs are certainly relevant, but this is a national and enduring crisis. If the GSEs have antiquated, inflexible systems, there’s no better time than the present to make needed changes.
His conclusion? A principal reduction program might not move the needle as much as we think. In his prepared remarks: "This is not about some huge difference-making program that will rescue the housing market. It is a debate about which tools, at the margin, better balance two goals: maximizing assistance to several hundred thousand homeowners while minimizing further cost to all other homeowners and taxpayers."

That’s a bit of a straw man. Principal modification that gave underwater homeowners some hope of rationalizing their debt could provide a real sense of confidence in housing markets hurt by foreclosures. Only when buyers can be confident that foreclosures will not cause prices to fall further and owners know they can sell their homes to at least cover their existing debt can housing markets return to normal functioning. That result would certainly be "nontrivial," to borrow the adjective.

Read DeMarco’s prepared statement here plus coverage in the Wall Street Journal.

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