New analyses by mortgage giants Freddie Mac and Fannie Mae have added an explosive new dimension to one of the most politically charged debates about the housing crisis: Whether to reduce the amount of money beleaguered homeowners owe on their mortgages.
Their conclusion: Such loan forgiveness wouldn't just help keep hundreds of thousands of families in their homes, it would also save Freddie and Fannie money. That, in turn, would help taxpayers, who bailed out the companies at a cost of more than $150 billion and are still on the hook for future losses.
The analyses, which have not been made public, were recently presented to the agency that controls the companies, the Federal Housing Finance Agency, according to two people familiar with the matter. Freddie Mac's meeting with the FHFA took place last week.
The decision of whether to allow such reductions rests with Edward DeMarco, the acting director of the FHFA, who has steadfastly opposed so-called principal reductions on the grounds that it's a bad business decision for the companies and would cost taxpayers money.
Many economists and policy makers contend that cutting principal — the amount of money lent to the homeowner — is one of the best solutions for keeping people in their homes and to bolster the fragile economic recovery.
But this solution has raised passionate opposition: Many borrowers who are paying their mortgages every month feel it is unfair. Why, they ask, should they have to keep paying the full amount while others who took a loan they ultimately couldn't afford or saw their house plummet in value get a break? Some economists and policy makers argue that borrowers might intentionally stop paying their mortgages to score a reduction. Indeed, the prospect that the government would help troubled homeowners was a spark that created the Tea Party movement.
The companies' new analyses were prompted by new Obama administration subsidies the government is offering Fannie and Freddie to reduce a homeowner's loan. But it's unclear whether DeMarco will take advantage of those incentives.
He declined to be interviewed for this story. But in a statement to ProPublica and NPR, DeMarco said that FHFA is assessing its position in light of the new Obama financial incentives, offered under the Home Affordable Modification Program, or HAMP. "As I have stated previously, FHFA is considering HAMP incentives for principal reduction and we have been having discussions with [Freddie and Fannie] and Treasury regarding our analysis."
Both Fannie and Freddie declined to comment.
As an independent regulator, DeMarco does not answer to the president and can make policies that the administration opposes. Obama sought to replace DeMarco, but his nominee was blocked by Republicans in the Senate, which must confirm the agency head.
As recently as Feb. 28th, DeMarco told the Senate banking committee, "Both companies have been reviewing principal forgiveness alternatives. Both have advised me that they do not believe it is in the best interest of the companies to do so."
Overall, principal reductions could help millions of borrowers who owe much more on their homes than their houses are worth, economists estimate.
And principal reductions can help lenders, because foreclosure often leads to bigger losses than reducing the amount owed. The biggest banks have long employed such reductions to curb their own losses.
The new analyses by Freddie and Fannie were done to assess the new financial incentives that the Obama administration announced in late January. ProPublica and NPR have not read the analyses, but two people described key aspects of them. The companies now find that reducing principal on troubled mortgages has a "positive net present value" — in other words, that doing it would bring in more money for the companies over the life of the loans than not doing it.
The two companies' analyses showed that upwards of a quarter million borrowers who owe more on their mortgages than their homes are worth could benefit from principal reductions. The companies would take a loss upfront, but over the long run these mortgage modifications would save the companies money because they would lead to lower default rates.
Experts have said that principal reductions are one of the best tools for helping homeowners stay in their homes.
"Principal reduction works," said Mark Zandi, chief economist of Moody's Analytics. "If someone gets a reduction in their principal amount, it gives them a real powerful hook to really fight to try to hold onto the home, even if things aren't going financially right for them."
The re-default rate for homeowners who receive a principal reduction is lower compared with the rate on other types of types of mortgage modifications, Zandi said.
Zandi estimates that principal modification could benefit 300,000 to 500,000 homeowners whose mortgages were backed by Fannie and Freddie. "And that would make a substantive difference," he says, in helping the housing market and boosting the economy.
"It saves taxpayers money and makes homeowners less likely to default," said Zandi. Given the Obama Administration's policy changes, "I'm now perplexed why DeMarco is not more fully engaged" in supporting principal reductions.
Not everyone supports principal modifications. Anthony Sanders at George Mason University says that implementing such reductions risks triggering a wave of strategic defaults, where people stop paying on their homes in order to qualify for a break. "DeMarco is absolutely right," he says.
The Obama administration's new initiative triples the subsidies. They now range from 18 cents to 63 cents on the dollar, based on conditions such as how deeply underwater a borrower is. The subsidy works out so that generally the Treasury would pick up about half of Freddie and Fannie's principal reductions, according to a person familiar with the incentives.
The subsidies are funded through HAMP, which used money from the Troubled Asset Relief Program (TARP), widely known as the bank bailout. Much of that money has not been spent.
Under DeMarco, the FHFA has allowed Fannie and Freddie to do principal forbearance, rather than principal reductions. In such a modification, borrowers' monthly payments are reduced, but they still must eventually pay back the entire loan. Critics contend that such modifications don't provide as much incentive as principal reductions for borrowers to keep paying.
Despite the new findings, it still might not make sense for Fannie and Freddie to do principal reductions. Such a program might require substantial and expensive changes to their computer and accounting systems and might distract from the core business. In his statement, DeMarco said, "FHFA's previously released analysis concluded that principal forgiveness did not provide benefits that were greater than principal forbearance as a loss mitigation tool. FHFA's assessment of the investor incentives now being offered will follow the previous evaluation, including consideration of the eligible universe, operational costs to implement such changes, and potential borrower incentive effects."
Yet even before the Obama administration's new subsidies, the FHFA's own data supported principal reductions for some borrowers, despite its opposition to using them, some argued. An American Banker analysis of the FHFA study, which the agency sent to Congress in January, suggested that principal reduction shouldn't be rejected so unequivocally.
Update: On Friday, following the publication of this story by ProPublica and NPR, lawmakers called on the Federal Housing Finance Administration to provide Congress with the new analyses on principal reductions by Fannie Mae and Freddie Mac. In addition, Illinois Attorney General Lisa Madigan urged FHFA to immediately implement appropriate principal reductions to home loans held by Fannie Mae and Freddie Mac.