A New Wrinkle in the Debate Over Principal Reduction

Representative Mel Watt, nominee for director of the Federal Housing Finance Agency Photograph Andrew Harrer/Bloomberg

For North Carolina Representative Mel Watt, the timing could have been better. Last November he and 44 other House Democrats asked the Congressional Budget Office to analyze the impact of allowing Fannie Mae and Freddie Mac to reduce principal for underwater homeowners, a move many Democrats support.

The CBO’s report came out yesterday, May 1—the same day President Obama nominated Watt to be the next director of the Federal Housing Finance Agency, which oversees Fannie and Freddie.

So what did the CBO find? If Fannie and Freddie were to reduce principal for underwater borrowers through the government’s Home Affordable Modification Program (HAMP), the impact would be positive but tepid. More than 10 million homeowners have mortgages still in negative equity, yet the CBO estimates only about 200,000 of them would be eligible for principal reduction through HAMP. That would reduce defaults for between 18,000 and 95,000 borrowers, depending on how much the loan balance is lowered. If the principal was reduced to 100 percent of the property’s value, the government (via Fannie and Freddie) would save $2.8 billion. “Designing a program that affected more borrowers and had a greater impact on the housing market and the economy would require a significant departure from HAMP’s current eligibility rules,” the CBO writes.

The report’s findings are a mixed blessing for Watt and other supporters of principal reduction. Yes, it would help some homeowners and save the government money—but not a meaningful amount. Republicans generally oppose mortgage-debt forgiveness, and may use Watt’s support of the idea as a reason to vote against him—saying that not only is it a bad idea, but according to the report, it wouldn’t even make much difference. And the debate could distract from an even bigger issue with a far wider impact: what the government should do with Fannie and Freddie in the future.

    Before it's here, it's on the Bloomberg Terminal.