May 16 (Bloomberg) -- The conservator of Fannie Mae and Freddie Mac may let servicers forgive debt on a limited number of mortgages owned or guaranteed by the taxpayer-owned companies, according to a person with direct knowledge of the discussions.
The model could be a new California effort that will pay for writedowns using federal dollars set aside for regions that have seen the worst housing-market declines, the person said. Because the government will bear the full costs of the California program, mortgages backed by the two government-sponsored enterprises will be eligible for the first time.
The Federal Housing Finance Agency currently bars principal reductions on all other troubled loans backed by Fannie Mae and Freddie Mac on the grounds that it would hurt the companies’ finances. So far, FHFA officials have resisted political pressure from congressional Democrats and financial incentives offered by the U.S. Treasury to change the policy.
FHFA Acting Director Edward J. DeMarco and other FHFA officials want to move beyond the principal-reduction debate and focus on winding down the two companies and bringing private capital back into the housing finance system, according to people familiar with their thinking. After delaying an announcement on loan forgiveness expected at the end of April, officials hope to release the new policy soon.
“It really is time for us to start thinking about and looking toward a more renewed and vibrant housing-finance system,” DeMarco said in a speech yesterday in Washington.
DeMarco, speaking to a conference of the National Association of Realtors, didn’t discuss loan writedowns. Instead, he touted the GSEs’ existing mortgage-modification programs, which often involve reducing monthly payments by charging zero interest on a portion of a loan and deferring its repayment.
Treasury officials in January offered Fannie Mae and Freddie Mac as much as 63 cents for each dollar of principal reduction, using unspent funds from the Troubled Asset Relief Program. The FHFA hasn’t released a final decision on whether to allow the companies to accept those payments.
DeMarco has said he is concerned that debt forgiveness would create new costs for the taxpayer-funded firms by encouraging defaults among borrowers who owe more than their homes are worth but who have kept making payments anyway. Three out of four underwater borrowers with GSE loans are current.
Treasury officials are downplaying expectations that there will be widespread reductions in principal on GSE loans.
“We’re suggesting that it be used only where the economics justify it relative to the probability and cost of a foreclosure, and that’s likely to be a relatively small number of loans,” Timothy G. Massad, assistant Treasury secretary for financial stability, said in an interview last week.
Beginning in June, the California effort will write down loans using Treasury funds from the Hardest Hit Fund, a different part of the TARP program than the other financial incentives offered by Treasury. The Hardest Hit Fund allocates assistance to states with the most serious housing-market declines. Currently, 18 states and the District of Columbia are participating in the $7.6 billion program.
The auditor for the TARP program last month released a report criticizing the Hardest Hit Fund, noting than only 3 percent of the money had been spent in part because of limited participation by the GSEs.
The key to the California program is that lenders will not bear any of the cost of principal reduction, which can reach $100,000 per loan. An FHFA program could take the same approach, the person said.
Fannie Mae and Freddie Mac were taken into U.S. conservatorship in 2008 after losses stemming from investments in risky loans brought them to the brink of insolvency. They have been sustained by almost $190 billion in taxpayer aid and DeMarco repeatedly has said he is legally bound to return them to solvency.
California officials estimate only as many as 9,000 homeowners could be helped by the state’s new program. Likewise, FHFA has said any nationwide principal reduction program would only apply to a small percentage of the 11 million underwater borrowers.
Fannie Mae and Freddie Mac have completed 1.1 million loan modifications since the end of 2008, and have engaged in more than 1 million other transactions to avert foreclosures, including short sales or repayment plans.
FHFA at the end of last year expanded the Home Affordable Refinance Program to make more underwater borrowers eligible to refinance into loans at lower interest rates.
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