FHFA Nears Decision on Principal Forgiveness

WASHINGTON — A decision by the Federal Housing Finance Agency on whether it will allow principal reduction on loans owned by Fannie Mae and Freddie Mac is imminent, the agency's leader said Wednesday.

Edward DeMarco, acting director of the agency, said FHFA would make a final determination later this month, a resolution that Treasury Secretary Tim Geithner hinted at during congressional hearings last month.

"We are currently evaluating the recent Treasury Department proposal to HAMP regarding principal forgiveness and expect a decision this month," DeMarco said in a speech before the Boston Security Analysts Society.

Most observers suspect that Fannie and Freddie will wind up doing more principal write-downs, but it will likely be fairly modest in both size and scope.

"The handwriting is on the wall," said Brian Gardner, a political analyst with Keefe, Bruyette & Woods. "In some ways, it will be consistent with everything else in housing and all the different policies and iterations of policies, it'll be incremental. We've haven't seen major shifts. We've seen modest steps along the way."

Principal reductions have emerged as a crucial issue in efforts to work out troubled loans threatened by foreclosure. An array of experts and officials have cited research showing write-downs as perhaps the only broad-based way to resolve bad credits short of mass foreclosures. But the government-sponsored enterprises, as well as others in the industry, have resisted such reductions.

In a sign of growing dissent, 30 U.S. senators sent a letter to DeMarco on Wednesday urging him to provide Congress within 30 days with accurate analysis of the effects on taxpayers of using principal forgiveness compared to other modification programs.

"We believe that FHFA must be fully transparent with this new analysis and look at targeted solutions for borrowers in different situations, rather than the 'all or nothing' approach that was used in the previous analysis," wrote Sen. Robert Menedez, D-N.J. chairman of the housing subcommittee and others.

In January, the agency, which regulates Fannie and Freddie, was asked by Treasury to reexamine its position on forgiving struggling borrowers' mortgages based on a new set of incentives included under the Obama administration's revamped Home Affordable Modification Program.

The White House is hoping that significant changes to the program will help extend its reach in the number of borrowers it can help refinance into cheaper loans.

But ultimately the final outcome will rest with DeMarco, a fact even Geithner acknowledged last month.

"The administration does not have any authority to compel the FHFA to undertake specific activities and under the conservatorship mandate they will have to make sure they meet a very tough test, appropriately so," said Geithner at a recent hearing. "He'll have to make these choices."

Still, that hasn't stopped the administration from trying to wield its influence on the final outcome.

A blog post by Michael Stegman, a counselor to Geithner on housing finance policy, sought to rebut recent claims that large banks will receive a windfall if the GSEs reduce the principal balance on first-lien mortgages they own. Taxpayers, he said, would be protected from this result, based on the alternative modification program Treasury has asked FHFA to examine.

Analysts said that Treasury has been pressuring DeMarco to change his position, even if slightly.

"Treasury absolutely wants this to happen and is in active conversation with FHFA," said Edward Mills, a financial policy analyst at FBR Capital Markets. "They're looking to try to figure out what gets DeMarco to yes."

The trouble that may arise, however, is that under Treasury's triple incentive program there will be some cases were principal reduction makes sense, but other cases where it doesn't, depending on a borrowers' loan-to-value ratio and length of delinquency. That could derail efforts to get DeMarco on board.

It will be a critical decision how policymakers discern whether it will be acceptable to apply principal reductions only to certain loans, the whole program, or none at all.

"At the end of the day, I think there is going to be some way of doing principal reduction," said Mills. "I don't think the program that Treasury has announced is going to do enough to meet what Ed DeMarco and what FHFA needed to see to sign on to it. I think there's going to be some level of negotiations, back and forth, where they are going to be able to use principal reduction as a tool, but not as a requirement."

DeMarco has been sharply criticized for his reluctance to forgive struggling borrowers' mortgages as a tool to help put an end to the rising number of foreclosures impacting Americans.

"It has been well-publicized that there is one form of loan modification that FHFA has not embraced, that being principal forgiveness," said DeMarco, in his speech. 'To be clear, the disagreement is not about helping borrowers."

Rep. Elijah Cummings, D-Md., ranking member of the House Oversight Government Reform Committee, has gone so far as to suggest that DeMarco should resign. He has also been pressing the FHFA to complete an information request by the committee this month. Documents were due at the end of the February, but the FHFA has asked for more time to complete the request.

DeMarco has repeatedly tried to make the case that he has dueling priorities — one of which is to protect the taxpayer from any future losses.

For now, he has stood by the agency's analysis, arguing principal reduction would not provide greater benefits than principal forbearance — a tool the agency has already been using.

On Wednesday, Demarco said the goal of any loan modification is to adjust the borrower's monthly payment to an affordable level.

"For many underwater borrowers, we achieve this by forbearing on principal — that is, charging a zero rate of interest on the forbearance amount and deferring its repayment," said DeMarco. "This focus on making the monthly mortgage payment affordable is an efficient way to provide assistance to the borrower and keep them in their home."

Perhaps foreshadowing the agency's ultimate decision, DeMarco argued that the principal forbearance model currently being used by Fannie and Freddie produces the "same, lower monthly payment" as a modification based on principal forgiveness.

"If the borrower ends up defaulting even with the modification, the loss to the taxpayer is the same either way," said DeMarco. "But if the borrower is successful, the taxpayer retains the opportunity to benefit from the upside — a reasonable deal given the support the taxpayer has provided to assist the family in keeping their home."

FHFA currently uses several tools to help borrowers prevent foreclosure including reducing interest rates, extending the term of the loan, and placing the underwater portion of the principal of the loan into forbearance.

Three out of four deeply underwater borrowers in Fannie and Freddie's book of business, he said, are current on their loans, showing a continued willingness by homeowners to meet their mortgage obligations.

"This should be recognized and encouraged, not dampened with incentives for people to not continue paying," said DeMarco.