BlackRock Inc., the world’s biggest money manager, criticized the state and federal settlement with banks over their faulty foreclosure practices and other government moves this year to increase mortgage forgiveness.
More reductions of home-loan balances in efforts to lower defaults could backfire by encouraging “underwater” borrowers currently paying on time to seek aid, potentially creating an “Armageddon scenario,” BlackRock Vice Chairman Barbara Novick said today at a press briefing.
“If you start having people who are currently paying their underwater mortgages say, ’Oh there’s a new entitlement program: My brother-in-law got a deal, my neighbor got a deal, my officemate got a deal, why shouldn’t I get a deal?’ then you’ve got a much, much bigger problem,” she said at the company’s offices in New York. “Not to belittle the current problem, but it would dwarf the current problem.”
President Barack Obama’s administration has sought to expand mortgage-principal cuts this year to bolster housing and consumers, through changes to its Home Affordable Modification Program and via the February settlement that servicers including Bank of America Corp. and JPMorgan Chase & Co. reached with the U.S. and state attorneys general. Almost 23 percent of borrowers are underwater, meaning they owe more than their homes are worth, according to real estate data firm CoreLogic Inc.
The so-called robo-signing accord is also unfair because it lets banks pay for their poor practices through changes to loans held within bonds and without writing off their own second-lien home-equity debt, Novick said. Her comments echoed those by investors including Pacific Investment Management Co., Angelo Gordon & Co. and DoubleLine Capital LP.
“I don’t understand why that’s not a headline every day until it gets reversed,” she said, referring to the credit that banks get under the $25 billion settlement for changes they make as servicers to investor-owned debt.
The Federal Housing Finance Agency, the overseer of Fannie Mae and Freddie Mac, has delayed deciding whether to allow the government-supported companies to step up their use of principal forgiveness as a result of the changes to HAMP. Edward J. DeMarco, the FHFA’s head, has cited the risk of fueling new defaults, saying three out of every four underwater homeowners with Fannie Mae and Freddie Mac loans are now paying on time.
Investors have been mixed on whether more principal reductions are warranted. Pimco and hedge fund manager Greg Lippmann have said that greater targeted use of the tactic may be beneficial for bondholders while Amherst Securities Group LP analyst Laurie Goodman says a housing recovery may be thwarted by future defaults that could otherwise reach 9 million.
Goodman’s analysis has shown principal cuts reduce defaults by underwater borrowers better than changes that only lower payments, while Credit Suisse Group AG analysts say they make little difference. Goldman Sachs Group Inc. said last week that underwater borrowers are defaulting less than before.
“The impact of negative equity on default decisions has become much more muted now compared to at the height of the housing downturn,” Goldman Sachs analyst Hui Shan wrote in a June 4 report.
Homeowners with loan-to-value ratios between 140 percent and 200 percent were 4 to 7 times more likely to default than those with ratios below 70 percent in 2008 and 2009, according to the report. That fell to 2.5 times in 2011 and 2012, all else being equal, Shun said.
U.S. Housing and Urban Development Secretary Shaun Donovan told a Senate panel last month that the efforts to expand principal cuts will reduce defaults. For Fannie Mae and Freddie Mac loans, balance reductions would only be used “where they actually benefit not just the homeowner but the taxpayer as well because there is more likelihood to repay.”
BlackRock’s Novick and Randy Robertson, head of its securitized-asset investment team, said at today’s briefing that government interference will damage future efforts to bring private capital back into the mortgage market without creating much higher costs for borrowers. Government-backed programs currently account for about 90 percent of new lending.
“How do I write a model based on public policy and whether contracts are going to be adhered to,” Robertson said.
Officials saying the foreclosure settlement won’t hurt investors because servicers must only take steps in bondholders’ best interest aren’t providing any comfort to investors because they can’t trust the tests will be done right, Robertson said.
BlackRock, which is supportive of efforts to allow more borrowers to refinance underwater Fannie Mae and Freddie Mac loans, is expecting a further 3 percent to 5 percent decline in U.S. home prices, though some markets are already recovering, according to a report by the firm released at the event.
Nationally, it will probably take 6.6 years for housing supply and demand to reach equilibrium, and as much as 26.4 years in a “bear” case, the firm says. Negative forces include retiring baby boomers, consumers’ weak finances, tight mortgage credit and the “regulatory uncertainty scaring off investors,” according to the report.