Freddie and Fannie Reject Debt Relief

By SHAILA DEWAN

 

Home values have fallen so much in Arizona that almost half the people with mortgages there owe more than their homes are worth. So when federal money became available to help stem the tide of foreclosures, the state flagged that group for help. 

If banks would forgive some of a homeowners’ mortgage debt, the state said it would pay half, up to $50,000 of a $100,000 loan reduction. Despite the generous terms, most banks balked.
Only three homeowners have been approved for debt reduction since the program began in September 2010. A major obstacle has been that the two largest mortgage guarantors, Fannie Mae and Freddie Mac, will not participate — in Arizona or elsewhere. No loans are eligible for the state’s program if they were bought and held or securitized by the two companies, which are now under government control and guarantee more than 70 percent of the country’s home loans.
“It is extremely difficult for the principal reduction program to be successful” when Fannie and Freddie opt out, said Shaun Rieve, a spokesman for the Arizona Department of Housing.
The companies’ policy against debt forgiveness, or principal reduction, has blocked widespread use of what many have come to believe is an indispensable tool for fixing the housing problem. The state attorneys general have been insisting that debt forgiveness be a part of the multibillion-dollar settlement they are negotiating with big banks over faulty mortgage practices.
Smaller investors and companies that service home loans have stepped up debt forgiveness as well.
Not so Edward J. DeMarco, who as acting director of the Federal Housing Finance Agency oversees Fannie and Freddie. Even though he recently signaled that he might make it easier for homeowners to refinance into more favorable loans, he has held his ground on debt relief. Fannie and Freddie say reducing the principal is bad for business, and as a result bad for taxpayers.
Critics counter that banks and investors have benefited from the government response to the housing collapse while borrowers have largely been left to sink. Last week the inspector general of the Federal Housing Finance Agency said that Freddie Mac had not pursued Bank of America aggressively for compensation for bad loans, despite warnings from a senior staff member.
“It’s sinful, is the word I would use, that they won’t do this,” said John Taylor, president of the National Community Reinvestment Corporation, referring to debt forgiveness. “And the only reason they won’t is they don’t want to realize the red ink that’s already on their books.” They are delaying taking inevitable losses on shaky loans.
White House officials say that although taxpayers essentially own Fannie and Freddie, the administration lacks authority to require Mr. DeMarco to comply with its policies, which encourage principal reduction through a handful of programs. The Federal Housing Administration and the Veterans Administration do not allow principal reduction on their loans either.
Large lenders have long resisted debt forgiveness because of fears that it creates a moral hazard, meaning it could encourage borrowers to take out risky loans in the future because the consequences would not be so bad, or to default to qualify for principal reduction. They argue that other types of loan modifications achieve the same goal.
Proponents of debt forgiveness argue that the failure to reduce debt is hurting the economy, postponing inevitable losses and costing more in the long run. While 28 percent of all loans that are modified go into default again within a year, loan modifications involving principal reduction are more successful. In the latest sign that debt forgiveness might make financial sense to some on the lender side, the nation’s second-largest mortgage insurance company, PMI Group, has found a way around Fannie and Freddie’s policy. PMI, which shares the credit risk in many Fannie and Freddie loans, will pay some underwater homeowners, those who owe more than their home is worth, if they make prompt payments for several years, a de facto principal reduction.
While the company would not disclose what percentage of the principal was covered, a spokesman for the Loan Value Group, which administers the program for PMI, said that on average it was 5 to 7 percent of the loan amount but could be as much as 30 percent.
1 Next Page  2