Nov. 4 (Bloomberg) -- Greg Lippmann, the former Deutsche Bank AG trader who gained fame for his bets against subprime mortgages before the housing market collapsed, is calling for debt forgiveness for U.S. homeowners.
“Principal reductions are necessary to help ameliorate the housing crisis,” Lippmann, chief investment officer for New York-based hedge fund LibreMax Capital LLC, said in an Oct. 31 letter to investors obtained by Bloomberg News. The step will also lower losses on loans underlying mortgage bonds, he said.
Lippmann, who co-founded LibreMax last year and oversees more than $900 million, joins a growing group of advocates for the increased use of mortgage modifications designed to keep borrowers in their homes by reducing their loan amounts. Current efforts to rework home loans mainly only lower monthly payments.
Pacific Investment Management Co., manager of the world’s largest bond fund, Harvard University economics professor Martin Feldstein and California’s attorney general are supporting mortgage forgiveness after the biggest drop in U.S. home values since the Great Depression left almost a quarter of mortgage borrowers owing more than their properties’ values, according to CoreLogic Inc. data.
Fannie Mae and Freddie Mac, the mortgage firms overseen by Federal Housing Finance Agency Acting Director Ed DeMarco, and lenders including Bank of America Corp. have resisted calls for widespread cuts to mortgage balances, saying the move is unnecessary or may encourage more homeowners to default.
“Prominent economists from both the left and the right” are calling for more principal reductions, Lippmann wrote in the letter. Borrowers are 1.7 times more likely to default again after a loan is reworked without cutting the balance, he said, citing a Deutsche Bank report last month.
Lippmann, who was featured in books on the financial crisis including Michael Lewis’s “The Big Short” and Greg Zuckerman’s “The Greatest Trade Ever,” declined to comment on the letter.
Less than 6 percent of mortgage modifications in the second quarter involved principal reductions, according to a report by the Office of the Comptroller of the Currency. President Barack Obama didn’t mandate greater use of balance cuts while last year adjusting the federal Home Affordable Modification Program in a way meant to encourage more debt forgiveness.
More than 10 million additional properties may be disposed of in distressed sales after defaults unless more balances are cut, according to Amherst Securities Group LP analyst Laurie Goodman. Fitch Ratings said in a report yesterday that it expects 45 percent to 55 percent of recently modified loans to re-default within 12 months.
‘The Real Problem’
Feldstein, who served as chief economic adviser to President Ronald Reagan, said on Sept. 14 during a Bloomberg Radio interview that “the administration’s program focuses on lowering interest rates, when the real problem is to get the creditors to renegotiate the principal.”
Other mortgage investors and policy makers are calling for initiatives aimed at dealing with the flood of properties set to be seized after defaults. Deepak Narula, head of hedge fund Metacapital Management LP, wrote in an Oct. 18 investor letter that there can be “perverse incentives associated with principal forgiveness.”
The U.S. should create a fund similar to 2008’s Troubled Asset Relief Program that could partner with private capital to buy “foreclosed or soon-to-be-foreclosed homes to add to the rental pool,” Narula said. TARP was mainly used to bolster banks’ capital.
‘Protect the Taxpayer’
“This strategy would go a long way towards ending the large overhang on the housing market of foreclosed homes, which would otherwise take several years to clear,” he said in the letter. Current owners could rent the properties while getting an option to buy them back, he said.
Narula, a former Lehman Brothers Holdings Inc. trader who started Metacapital in 2001 and manages almost $800 million in his main fund, declined to comment further.
DeMarco, the regulator for government-supported Fannie Mae and Freddie Mac, defended the companies’ stance on debt forgiveness to lawmakers yesterday.
“We can get the borrower to” an affordable “payment without doing principal forgiveness, and we better protect the taxpayer by preserving an upside potential if the borrower is successful in their modification,” he told a House panel.
DeMarco’s agency joined in the government’s request for ideas in August on how to deal with property inventory tied to U.S. programs, which focused on potential plans to turn foreclosed homes into rentals.
Kamala D. Harris, California’s Democratic attorney general, said in an e-mailed statement yesterday that “if Mr. DeMarco is unwilling to support principal reduction for these home loans in crisis, he should step aside for someone who will.”
Pimco favors more principal forgiveness for underwater borrowers who are seriously delinquent, Scott Simon, its mortgage head, said yesterday in a telephone interview.
Many mortgage-bond holders want homeowners to have their balances cut to levels that would allow them to qualify for refinancing out of the pools backing the securities, he said. Banks’ unrecognized losses on second-lien home equity debt are causing the companies not to pursue such a strategy when acting as servicers, he said.
“It’s in the best interest of both the lender and the borrower but typically not in the best interest of the servicer,” Simon said.
Terry Laughlin, Bank of America’s chief risk officer, focused during an April presentation to investors on the “fundamental fairness issue” stemming from rewarding some borrowers and on whether doing so would increase defaults.
“If you give principal forgiveness to one borrower, it’s a very slippery slope,” he said.
The Charlotte, North Carolina-based bank, the largest U.S. mortgage servicer, does “offer principal reduction in certain product and customer situations -- where we have delegated authority to do so,” Dan Frahm, a spokesman, said in an e-mail.
During the financial crisis of 2007 and 2008 sparked by soaring defaults, Lippmann helped Deutsche Bank offset losses on mortgage investments with wagers against subprime debt that made $1.5 billion, according to an April report by a Senate panel.
LibreMax has sought a “diverse group” of mortgage securities for its portfolio whose total performance would be “reasonably insulated with regard to different modification outcomes,” he wrote this week. Principal reductions hurt some slices of securitizations while helping others, he said.
His main fund gained 2.5 percent last quarter, boosting returns for this year through September to 5.6 percent, according to the letter. The fund has advanced about 10 percent since its inception in October 2010.
Metacapital’s fund, which unlike Lippmann’s also wagers on government-backed mortgage bonds, lost about 5.5 percent last quarter, reducing gains in the first nine months of 2011 to 15 percent, its letter said.
To contact the editor responsible for this story: Alan Goldstein at email@example.com