DeMarco Holds the Line, Rejects Principal Reductions

WASHINGTON — Edward DeMarco, the acting director of the Federal Housing Finance Agency, on Tuesday defied both the Obama administration and widespread expectations that he would cave to a torrent of political pressure and allow Fannie Mae and Freddie Mac to offer principal reductions to troubled borrowers.

The decision followed months of back and forth between the FHFA and the Treasury Department, with Secretary Tim Geithner repeatedly urging DeMarco to reverse his long-standing opposition to allowing the government-sponsored enterprises to participate in a government program to wipe out portions of mortgages for underwater borrowers.

But in the end, the numbers ruled, DeMarco said, pointing to figures that showed that if consumers engaged in strategic defaults as a result of the program, it would increase losses to the GSEs - and, by proxy, taxpayers, since both companies are still in conservatorship. Although the FHFA concluded principal reductions could save taxpayers between $100 million to $500 million, he said 3,000 to 19,000 defaults could wipe out those gains.

"We spent six months doing this analytical work, studying this issue, looking at the other programs available and engaging in discussions with the Treasury Department," DeMarco told reporters at a briefing. "We are providing the results of that. We had to make a decision. We made a decision. Others will now look at this and form their judgments of what we've concluded."

DeMarco added that the cost of creating the program at the GSEs, as well as added expenses to mortgage servicers, would cost as much as $90 million. Staff resources would also wind up being diverted to the new program — which could take more than a year to get up and running — rather than current loss mitigation efforts, he said.

Moreover, FHFA said the program would only benefit 74,000 to 248,000 borrowers, some of which are already eligible for a standard loan modification.

"We weighed these potential benefits and costs, recognizing the inherent uncertainties associated with these estimates," DeMarco said. "We concluded that the potential benefit was too small and uncertain relative to known and unknown costs and risks to warrant Fannie and Freddie implementing" principal reductions.

But the decision remained highly controversial, with Geithner immediately saying DeMarco had made the wrong move.

"I do not believe it is the best decision for the country, because as we have discussed many times, the use of targeted principal reduction by the GSEs would provide much needed help to a significant number of troubled homeowners, help repair the nation's housing market, and result in a net benefit to taxpayers," Geithner wrote in a letter to DeMarco.

He was seconded by Rep. Elijah Cumming, D-Md., ranking member of the House Oversight and Government Reform Committee, who has previously called for DeMarco's ouster.

"It is incomprehensible that Mr. DeMarco would reject the chance to save up to a billion dollars in taxpayer funds while helping nearly half a million homeowners stay in their homes," said Cummings, in a press release. "He should immediately withdraw this reckless and misguided letter and start following the law Congress passed."

Treasury has argued allowing the GSEs to participate in the principal reduction program could help up to half a million homeowners and result in a savings of $3.6 billion compared to a standard GSE modification. It would also save taxpayers as much as $1 billion on a net basis.

But DeMarco said the administration's numbers are skewed. The $1 billion tax benefit depends on every eligible homeowner for the nearly 500,000 loans outstanding actually taking advantage of the program — a far cry from reality.

"This is assuming … that every single borrower eligible for these modifications takes the modifications," said DeMarco. "That's a 100% take-up rate, which of course is nowhere close to anything one might reasonably expect or what we've actually experienced."

The FHFA's analysis shows that if only half of eligible struggling borrowers were to take advantage of the program, it would potentially generate $500 million in benefits to the taxpayer. But that number could drop precipitously depending on other factors, including the number of delinquent borrowers who might be excluded from the program. If, for example, borrowers who missed a year of payments were excluded, the potential benefit of the program would fall to just $100 million. If borrowers who missed six months of payments were excluded, there would be no benefit to the taxpayer.

DeMarco said the agency felt responsible to provide transparency about the analysis it did and the array of factors that it considered in making its decision.

"We felt we had a responsibility to be thorough in our analysis and then as transparent to Congress and to the public about that analysis so that others can judge," said DeMarco. "There's a judgment involved here and so what we're trying to lay out to policymakers is to understand the basis upon which the agency made what I consider a challenging decision."

For their part, Republicans like Rep. Scott Garrett of New Jersey, chairman of the House Financial Services subcommittee on capital markets and government sponsored enterprises, applauded the decision.

"I praise Director DeMarco's decision to protect the American taxpayer by preventing the Obama Administration from continuing to exploit the bailout of the GSEs to push their own social housing goals," said Garrett, in a press release. "This thoughtful and analytical decision making process should be used as model for the rest of Washington's bureaucrats before they make decisions without properly considering the costs and benefits to the taxpayer."

The move was also backed by David H. Stevens, president and CEO of the Mortgage Bankers Association and the former commissioner of the Federal Housing Administration.

"We agree that principal forbearance can help borrowers realize a payment reduction in a similar way as principal reduction," said Stevens, in a press release. "It is critical to implement solutions that help the American homeowner without incurring the negative long-term impact of making credit less available and more expensive."