Tuesday, July 31, 2012

New FHFA Analysis is Reported to Show Principal Reduction Saves Taxpayers Money

This is potentially very important to the Valley Economy.  The Wall Street Journal reports,

As the regulator for Fannie Mae and Freddie Mac nears its decision on whether to approve debt forgiveness for troubled borrowers, a new analysis by the regulator suggests taxpayers could benefit from the move, according to people briefed on the findings...
The Obama administration has argued strongly in favor of the FHFA adopting the principal-reduction program for Fannie and Freddie, saying it would provide more sustainable loan modifications. "We think there's a set of cases where it's clearly in the interest of the taxpayer for them to do principal reduction upfront," said Treasury Secretary Timothy Geithner in congressional testimony earlier this year.

In April, the agency said that loan forgiveness would save about $1.7 billion for the companies, relative to other types of relief. At the time, the agency said that because the Treasury was paying to subsidize those write-downs, the relief would still cost taxpayers $2.1 billion, offsetting any savings to the companies.

But the latest analysis done by the agency found that such write-downs would generate $3.6 billion in savings for the companies, under certain assumptions, according to people familiar with the analysis. Even after subtracting the cost of the Treasury subsidies, the program would save $1 billion, these people said. As many as 500,000 borrowers could be eligible, these people said....
The Treasury Department rolled out the debt-forgiveness program in 2010. Fannie and Freddie opted against participating. The initiative, part of the administration's Home Affordable Modification Program, is open to homeowners who have missed their mortgage payments or face imminent hardship and who owe more than their homes are worth.

The program has been increasingly adopted by mortgage servicers that handle deeply underwater loans which aren't guaranteed by Fannie and Freddie. To qualify, homeowners must make at least three payments under the reduced loan amount, and principal balances are cut in installments over three years. The median principal amount reduced under the program has been $69,000.
It will be interesting to see the analysis, but the results make sense to me.  Every incremental improvement to resolving unsustainable, underwater mortgages moves us a little closer to the end of this nightmare.

Update:  Not long after I post this, FHFA announces that Fannie and Freddie will not offer principal reduction.  It is interesting that FHFA is worried about the Treasury subsidy and the possibility of a relatively small net loss to taxpayers on a nationwide basis.  I think Treasury is willing to take that risk, because they see it as a much needed investment in improving the economy and neighborhoods. 

If the Treasurey investment shortened the duration of the foreclosure crisis by only a few months, it may be well worth the investment. But with something like 3-4 million mortgages severely delinquent or in foreclosure out of a roughly 10 million underwater, how much would the program really help?  Best case scenario, it seems it might cut future foreclosures by 10%, probably more like 3-4%.  So it probably wouldn't do more than shorten the foreclosure crisis by 1-3 months of what looks like another 3-4 years.  It still seems a good bet to me, but I am tired of wasting energy on this lost cause.  I am just grateful that they have at least enhanced the HAMP program


  1. I don't know why principal reduction should not be coupled with a debt-equity swap. If the lender is going to take a haircut on the principal, he should get an undivided interest in the house. In fifteen years, if things work out, both parties would have been treated fairly.

  2. You are right, this would be a productive direction.

    Some posts from years ago on this blog endorse a similar concept, shared appreciation mortgages, that many economists were advocating from the beginning of the crisis. Whomever financed the principal write-down, lender or taxpayers, would split any future appreciation above the new loan balance if home were sold in the future.