The Obama administration was shocked this week when a federal regulator did his job.
It began when Edward DeMarco, the acting director of the Federal Housing Finance Agency, said Fannie Mae and Freddie Mac couldn’t extend mortgage reductions to troubled homeowners who owe more than their property is worth. The administration had been pressuring DeMarco, whose agency oversees the taxpayer- supported mortgage giants while they are in conservatorship, to permit them to eliminate a portion of the loan amount owed to the lender or investor.
“The potential benefit was too small and uncertain relative to known and unknown costs and risks,” DeMarco said. This view contradicted the conclusions of a recent report by his agency stating that Fannie Mae and Freddie Mac would benefit by $1.8 billion if principal reductions were allowed. Advocates of the program have argued it benefits both borrowers and taxpayers, because it can be used to avoid costly foreclosures.
Treasury Secretary Timothy Geithner was quick to object. “The use of the targeted principal reductions by the GSEs,” he said, referring to the government-sponsored enterprises, “would provide much-needed help to a significant number of troubled homeowners.”
That would be a hasty conclusion. There are 13 administration loan-modification programs already. They include the Home Affordable Modification Program (commonly called HAMP) and the revamped Home Affordable Refinance Program, called HARP 2.0.
There is also the so-called attorneys general settlement, a conglomeration of changes in loan-service standards that includes principal-reduction requirements for modifying loans, and other measures to lower homeowners’ mortgage debt. In addition, the Treasury Department’s Hardest Hit Fund helps underwater borrowers in the same states. Rather than turning Fannie Mae and Freddie Mac into a supercharged HARP, DeMarco showed wise judgment by waiting to see how all these programs play out.
And why the rush by Geithner? Fannie and Freddie have 4.6 million underwater borrowers -- less than half the national total of 11 million -- and 75 percent of them are current on their loans.
It is wise to wait for other reasons as well. There is a mortgage refinancing wave in progress, with HARP volume representing 20 percent of all refinancings in May. And states have their own efforts.
Proposals keep popping up. Recently, San Bernardino County in California said it was considering the use of eminent domain to seize loans from private-label mortgage-backed securities and to write down the principal on those loans. If that action is determined to be constitutional and becomes a popular tactic used by local governments, we could see a dramatic change in the fortunes of mortgage investors for the worse since it could alter the cash flows they will receive.
On top of all these developments, the U.S. Senate is considering yet another change in the HARP 2.0 program, sponsored by Democratic Senators Robert Menendez and Barbara Boxer. Their bill proposes to streamline refinancing of mortgages held and insured by Fannie Mae and Freddie Mac -- akin to removing the safety from a torpedo.
Studies of small principal-reduction programs show that they can work in lowering default. But the Obama administration is talking about a major change in policy without evidence showing how it would actually work.
The Federal Housing Finance Agency is also concerned about the moral hazard aspect. If the Treasury Department essentially puts up signs saying, “If you’re 90 days late on your mortgage, you’ll get a Fannie/Freddie principal reduction,” imagine how many households would suddenly stop paying their mortgages.
Finally, we should look at the big picture. Why should federal taxpayers be held responsible? Someone in Texas shouldn’t be paying for someone’s principal reduction in California. We shouldn’t expect cities to cover the loan balances of other cities. The better alternative is to promote economic growth and lower unemployment in the suffering cities.
Of most concern is the government’s potential invasion into the private sector, whether through forced loan modifications or eminent domain. Fannie Mae and Freddie Mac are private corporations that happen to be in conservatorship. Should the federal government really be mandating what Fannie Mae and Freddie Mac do with their loans or mortgage-backed securities?
Continual shocks to the housing and mortgage markets are counterproductive, and that is what the Obama administration is risking. While the administration may not agree with DeMarco’s decision this week, it should recognize that he took his charge as regulator seriously, rather than acting as a mere facilitator. The FHFA can reconsider the principal-reduction decision -- after the presidential election in November.
Today’s highlights: the editors on India’s power failures and on how Congress failed on cybersecurity; Stephen L. Carter on educational inequality; Ezra Klein on Mitt Romney’s exploding tax plan; William Pesek on higher food prices and Asia’s poor; Virginia Postrel on the historical lie behind “you didn’t build that”; Jonathan Weil on stopping wrongdoing by banks; Richard Cohen on the changing of the guard in Olympic fencing; Mohamed El-Erian on why central bankers can’t save the world; Handel Reynolds on cancers we don’t need to know about.
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