Gretchen Morgenson’s bizarre defense of Ed DeMarco

By Felix Salmon
March 25, 2012
myself included, who would love him to allow Frannie to do principal reductions where it makes sense. But now he's managed to find a defender. In Gretchen Morgenson, of all people.

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Ed DeMarco, the regulator in charge of Fannie Mae and Freddie Mac, has many critics, myself included, who would love him to allow Frannie to do principal reductions where it makes sense. But now he’s managed to find a defender. In Gretchen Morgenson, of all people.

Morgenson’s column today is utterly bizarre. She starts off by painting DeMarco as a “career public servant”, “under fire” in a “thankless job”. This is a phrase she seems to reserve for DeMarco alone: she made sure to describe him as a “career public servant” in 2010, as well as in her book. And as far as I can tell, she’s described no one else that way. And there are many career public servants, up to and including Tim Geithner, who can’t stand DeMarco* and who think he is being deliberately obstructionist here.

Morgenson then defends DeMarco from critics like Barney Frank and Elijah Cummings:

What the proponents of principal reductions at Fannie and Freddie don’t talk about is what a transfer of wealth from taxpayers (again) to large banks such a program would represent.

Morgenson is actually serious about this: the headline on her column is “A Bailout by Another Name”. And when she says bailout, she doesn’t mean a bailout of deadbeat homeowners, who would see their net worth jump overnight as a bunch of their obligations were written off at a stroke. No, she means a bailout of banks.

On the face of it, this makes no sense. How can reducing homeowners’ principal end up as a bailout of banks? And not just any bailout, either: Morgenson goes on to tell us that such a program “would constitute a direct and sizable gift from taxpayers to the largest banks”, “another backdoor bailout for the banks that brought you the mortgage crisis”, and “another stealth bank bailout, courtesy of taxpayers”.

Don’t worry, Morgenson does actually spell out her thesis here. In her 1,170-word column, she spends a full 65 words explaining exactly how principal writedowns are in fact a “direct and sizable gift” to banks. So I may as well quote those words in full:

Many banks hold second liens on the same properties for which Fannie and Freddie either own the first mortgage or have guaranteed. If principal amounts on these first mortgages are reduced while leaving the second liens intact, those seconds become much more likely to be paid off over time. With no principal reduction, the banks would have to write off many of those second liens.

That’s it. I don’t know what your idea of a “direct gift” is, but I’m pretty sure it’s not this. Even if Morgenson’s argument here made sense, which it doesn’t, the gift would at best be indirect. And there’s nothing here at all indicating that it’s sizable.

More to the point, Morgenson’s whole argument, such as it is, is based on a classic straw man — that the holder of the first lien would be perfectly happy to write down a large chunk of what they were owed without any kind of write-down whatsoever on the part of second-lien holders. As far as I know, nobody advocating principal reductions is proposing this.*

It’s worth remembering here, that the whole point of principal reductions is that when people are underwater on their homes, they’re much more likely to default than when they have equity in their homes. If you reduce principal to the point at which the homeowner has positive equity again, then you’re more likely to get repaid, and you can end up with a more valuable loan than one with a higher face value.

But if there’s a second lien on the house in question, then even if the first lien is reduced to less than the value of the property, the homeowner would still be underwater, thanks to that second lien. Which would quite literally defeat the purpose of reducing the principal on the first lien.

Banks holding first mortgages negotiate with banks holding second mortgages all the time. If the homeowner is in default, then the owner of the first lien is in a strong negotiating position: they can foreclose on the home, sell it, and take all the proceeds, leaving nothing at all for the holder of the second lien. And because the second-lien holder is well aware that the first-lien holder has that nuclear option, they’re normally well disposed to negotiate: they’ll accept $5,000, say, to write off their debt.

Why does Morgenson think that wouldn’t happen here? She doesn’t say — after all, her entire argument is just 65 words. But she does go on at some length about the loan modifications which we are seeing from Frannie — more than 1.1 million, to date, with an impressively low redefault rate. She writes:

This suggests that the types of loan modifications provided by Fannie and Freddie — reducing borrowers’ monthly payments — are working fairly well. Addressing borrowers’ ability to repay loans has been the focus, Mr. DeMarco said. At the same time, these changes in loan terms do not encourage people to default in spite of being able to pay.

What Morgenson doesn’t seem to realize, here, is that exactly the same argument that she’s marshaling against principal reductions could be used against loan modifications as well. If you reduce borrowers’ monthly payments, and increase their ability to repay their loans, then quite obviously you’re also increasing their ability to repay second liens as well. And if you do a loan modification rather than foreclose on the delinquent borrower, then the second lien holder isn’t wiped out and the homeowner can continue to pay off their second lien over time.

So how is it that principal reductions are a giveaway to banks, but loan modifications aren’t? Morgenson even says that loan modifications don’t encourage people to default on their original loans, which would seem to be an argument for principal reduction: the moral-hazard argument, that such things only serve to give people an incentive to default, seems already to have been disproven with the loan-modification program.

Remember, too, that Morgenson said in her 65-word argument that “with no principal reduction, the banks would have to write off many of those second liens”. Something doesn’t add up here. After all, banks will never voluntarily write off a second lien if the homeowner gets a loan modification which increases their ability to repay their debts. So if Frannie is great at loan mods, then they must also be great at forcing second-lien holders to write off their loans at the same time. But if they can do that with a loan mod, they should be able to do it with a principal reduction, too. And if they don’t do that with loan mods, then the banks wouldn’t otherwise be forced to write off those second liens.

And we haven’t even touched, yet, on the most obvious and silliest part of Morgenson’s case — which is that most of Frannie’s delinquent mortgages don’t have second liens attached. DeMarco doesn’t like the idea of doing principal reductions on homes with second liens? Fine, don’t do it, then. But that’s no reason not to do principal reductions on loans without second liens.

More generally, DeMarco is just the regulator, here — he’s not actually running Fannie and Freddie. If he lifted his injunction on principal reductions, then we wouldn’t suddenly see a huge influx of the things overnight. These agencies move slowly and deliberately, and they’d almost certainly start small, and only on homes where there weren’t second liens. If that program worked, then they’d expand it, taking just as much care in doing so.

Morgenson’s argument implies that were it not for DeMarco holding back the floodgates, Fannie and Freddie would be doing principal reductions on a massive and reckless scale, without even trying to involve banks holding second liens. She has no reason to believe this, because it isn’t true. The agencies might be philosophically inclined — for good reason — to do principal reductions, but only when and because they make financial sense. DeMarco, on the other hand, seems to have some kind of quasi-religious belief that principal reductions never make financial sense. And his arguments to that effect are extremely weak.

But not as weak, it must be said, as Morgenson’s effort today. If principal reductions really would be “a direct and sizable gift from taxpayers to the largest banks”, then the largest banks would surely be pushing loudly for their implementation. But they’re not. Because the principle beneficiaries of principal reductions are not banks, but rather homeowners — the people whom Gretchen Morgenson wants to see continuing to suffer under the weight of mortgages worth far more than their homes. And all because of some inchoate and irrational animus she has towards Fannie and Freddie.

*Update: Anthony Coley at Treasury emails to say that Geithner “has tremendous respect for Mr. DeMarco”, even as he thinks “there’s a pretty strong economic case for principal reduction as part of a strategy to limit the future losses of the GSEs. What Treasury is trying to do is encourage Mr. DeMarco, who is fully independent, to take another look at the evidence because we think there’s a place to do more in a way that is consistent with the mandate that Congress gave him.”

And Shahien Nasiripour, who’s been getting the same line from DeMarco, points out that there is at least one person who thinks that principal reductions should be done absent write-downs on second liens: NY Fed president William Dudley.


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Morgenson’s argument is to stress the idea that the big banks haven’t helped borrowers like Fannie and Freddie have already done, and the big banks hold most of the underwater mortgages:
“The concentration of loans >115% Loan-To-Value is more than five times greater for PLS (private lenders) than for the GSEs”, says the FHFA.

Don’t want to read it?
It’s time to force the big banks to help borrowers, like FnF are doing since 4 years ago.

Felix Salmon is another Henry Paulson’s boy, trying to protect the big banks and increase FnF’s losses.

Posted by GJOA | Report as abusive

I agree with Morgansen, Reducing the balance on Fannie/Freddie 1st lien mortgages increases the value and the likelihood of pay-back on bank held 2nd liens. We seem to have contract law backwards in this country these days, where investor held 1st liens are more at risk than bank held second liens. Also ironic to hear that Fannie & Freddie have to put the tax-payer on the hook for more losses these days, despite giving Demarco the opposite mandate.

You and Demarco’s critics are confusing two issues here. First is rule of law, second is caveat emptor. That banks didn’t follow the rules and engaged in robo-signing must end and be punished(it wasn’t) but the vast majority of borrowers knowingly bought more home than they should and it’s not Fannie Mae’s job to subsidize that. A mortgage modification/forgiveness should be done when it saves the lender money over foreclosure and that also means following the legal waterfall and wiping out the 2nd lien first.

Posted by Sechel | Report as abusive

You nailed it. In the end, the “robosigning” scandal had the objective to speed up the foreclosure process so that the big banks protect their 2nd lien mortgage.
The 2nd lien mortagages held into the big banks’ balance sheets must be wiped out before the 1st lien defaults.
But the politicians paid by the big banks don’t want it.
The bankers-politicians linkage is the disease of the world.

Occupy Congress movement has just begun. Enough is enough.

Posted by GJOA | Report as abusive

Way too many moving parts in this matter to competently address it in blog posts. I’m with Morgenson (damn, it hurts to say that!) on this one.

Fairness I – Seconds have to be wiped-out before Firsts take any losses; that’s just basic mortgage law. Ignoring that principal does amount to a gift by FnF (meaning – taxpayers) to irresponsible borrowers and their Second lenders. Wiping-out Seconds destroys the balance sheets of the banks holding them, necessitating yet another taxpayer gift to them to get them solvent again. Doing that (again) without wiping-out shareholders and managements could inspire open rebellion.

Fairness II – In “recourse” jurisdictions underwater borrowers are personally liable for any unpaid mortgage debt after foreclosure. How does one ethically justify forgiving that debt outside of bankruptcy proceedings? Planning to do the same for hopelessly indebted student-loan borrowers – hardly fair to students who worked and saved and didn’t borrow, is it?

Fairness III – How does one ethically justify “gifts” in the form of debt forgiveness to some debtors but not others? Why should those irresponsible borrowers who took on debt of 90%+ LTV get a reward that people who were cautious and conservative and put down 50% (or 100%) don’t get – they’ve all taken the same “hit” in terms of house prices, haven’t they?

Posted by MrRFox | Report as abusive

MrRFox, “fairness” is relative here. Let’s go for the alternative. I walk away from my house and chapter 7 myself. Everything is discharged. Done.

Who eats the losses here? The bank? Or do you and I pay more in points, fees, and interest to make up for this loss? What about mortgage insurance that kicks in? Does the bank just eat the loss, or does it raise fees on everyone to stay profitable? What about government agencies that now are holding the bag? Tax money spent here too? Who’s?

And in bankruptcy all debts are discharged including credit cards. Who pays for that? You and me? Do the banks keep the interest rates we all pay high because of the losses? Of course they do.

So, you see, you’re being completely disingenuous here. We all pay no matter what. You just want to look at this as a moral issue and I want to look at it as a contract issue. There’s no morality here because we all pay for the losses one way or another. So how do we mitigate this such that we minimize this loss? That’s the point, not moralizing about it. Drop the ethics because you’re incorrect in assuming there’s no bailout. There is regardless and we’re all paying it one way or another. Your choice whether you prefer it through the back door of higher general costs or the front door.

Posted by skyman123 | Report as abusive

Shyboy123 posted – ” Let’s go for the alternative. I walk away from my house and chapter 7 myself. Everything is discharged. Done.”

Yes, and everything you have is taken from you and applied to your debts, and your credit standing is ruined for 7 years. YOU come out of that with nothing – that’s how bankruptcy works, and should work. What you want is to have your debt forgiveness and keep all your other assets for yourself. Fair? IDTS.

Posted by MrRFox | Report as abusive

Many, many of the underwater borrowers were flippers and speculators. Why would you want to help them? The media needs to stop painting every borrower with the same brush. How about second and third homes?

And while we are at it, can you write an article about the injustice of having paid $118 for my yahoo stock in early 2000? Somebody has to be made responsible for passing me the bag. It’s not fair that 12 years later I am still underwater! I want the SEC to retroactively reset my entry price at $10 for a normalized 4% gain over the last decade.

Posted by rros | Report as abusive

My buddy’s father in law recently went through a short sale on his underwater house. Total loss is 100k. He also has a shore house that the bank is not going after. How do you make a decision to buy more house than you can afford then short sale it take a loss of 100k and not have the bank come after other assets? The shore house is located in Delaware not Florida? This just sounds to generous. Hell, how do i get money back on my mortgage? I overpaid by 40k.

Posted by david0921 | Report as abusive

Why bother with contract law and/or morality? We can just make up the law as we go…who cares who pays for it. Simple, we can just tell note holders that it is in the best interest for the country to write down some principal… AS LONG AS I AM NOT THE NOTE HOLDER!!!

Posted by alexfromCal | Report as abusive

This is for David0921: Ask Mr. Salmon to co-sign for you. A true progressive never worries as long as someone else pays for it. Let’s see if he wants to put his money where his mouth is?

Posted by alexfromCal | Report as abusive

I refuse to defend Morgenson on principle, but Felix’ objections don’t hold water.

* Plenty of evidence demonstrating that this isn’t a black-and-white issue. If one borrower is 5% underwater and another is 50% underwater, then the second is far more likely to default. The critical value seems to be around 25% from what I’ve read, after which defaults start to spike. Modifying the first lien (even without touching the second lien) can definitely bring the degree to which the property is underwater below this critical value.

* Skyman writes, “There’s no morality here because we all pay for the losses one way or another.” Which is true — but often the best way to minimize the socialized losses is to place the bulk of the burden on the borrower. Moreover, while the term “moral hazard” may not truly be about morality, it is definitely applicable to this kind of situation.

* As usual, MrRFox puts it very well.

Posted by TFF | Report as abusive

There is no reason to give a reduction to a person who can afford the payment and doesn’t need to move. They are essentially renters and there’s nothing wrong with renters. If at some point they decide to default then let them. I just don’t see why we should continue to bail out anyone involved in this fiasco. In 10 or 20 years when they have paid off the loan, the value may or may not have recovered. Are we going to make up the difference then too?

Posted by silliness | Report as abusive

David, if I understand it properly, Florida is a non-recourse state. By contract, the bank can take the Florida house but it can’t chase the borrower for other assets.

Posted by TFF | Report as abusive

Lots of good comments made so far in the comments, and I am not totally convinced that Salmon doesn’t have a legit point against Morgenson. But I do want to make a point that I haven’t seen here so far and that Salmon has a weird way of being oblivious to.

The victims of principal reductions would obviously be taxpayers, but there’s a subset of taxpayers who will be paying in some small way to subside the people who, during the bubble, went out and took out loans to buy more house(es) than they could afford.

The taxpayers who stood on the sidelines during the bubble, waiting for the price level to return to the level indicated by the fundamentals, are being hurt twice here: first, they’re having their taxes being used to soften the blow to people who acted irresponsibly during the bubble by buying second and third homes, or homes they couldn’t afford via unsustainable lending practices (NINJA loans, Negative ARMS, etc.).

Second, now the price level is being artificially propped up at a higher level than it should be because the homes that normally would be foreclosed upon and re-sold on the open market, aiding in true price discovery, are being held off the market via all these “programs” like HAMP and the various refinancing schemes, which means that a home that would normally be in their price range when the non-bubble price level is reached, is still out of reach.

You never hear any commentators talk about these taxpayers, but they are the true victims of the bubble and are being victimized again by bailouts of irresponsible borrowers, regardless of how that bailout (principal reductions, refinancings, short sales, etc.) takes place.

Posted by Strych09 | Report as abusive

“We finally placed an offer on a two-bedroom, 811-square-foot apartment near downtown Oakland for $385 thousand, with a cash down payment of $100 thousand…”

“Our realtor and credit union loan officer convinced us to sign a five-year, interest-only ARM loan, since we intended to own the property for less than that time. They made it sound so easy, so simple, to make money on this secure, sound investment. We were plunging into the most sensible financial venture, like every responsible American should.”  /phan_03_15_2012/

I feel bad for them (they lost their condo in foreclosure) but why are they deserving of help? They were given the down payment by their parents and their plan consisted of hoping the market value of the condo would go up enough to bail them out of a foolish deal.

So the real estate agent and loan officer screwed them over. Go figure.

Posted by silliness | Report as abusive

“And there are many career public servants, up to and including Tim Geithner, who can’t stand DeMarco and who think he is being deliberately obstructionist here.”

Sure, and Geithner had the same attitude toward Elizabeth Warren and anyone else not sufficiently subservient to Wall Street interests. I mean, if Geithner thinks he’s being obstructionist, that suggests a point in his favor, because in Geithner’s world, “obstructionist” means “preventing the flow of funds to banks.” The Treasury and the Fed have made it pretty clear they want to help the banks protect the value of their 2nd lien loan books.

Posted by Moopheus | Report as abusive

“vast majority of borrowers knowingly bought more home than they should”

Sez who? Let’s see a source for this. Sure, some borrowers knowingly bought more home than they should. Others lost jobs or lost income — this is the majority of borrowers I know, but let’s get some evidence here before relying on anecdotes. Finally, we’ve got the poor saps who were duped into buying more home than they should have — people with little financial sophistication, and in some cases limited command of English, who were told, “don’t worry, you can always refinance” and the like.

That’s three categories of borrowers, and I don’t know what the breakdown is, and I doubt anyone else really does either at the moment. If anyone does, let’s see some data. I suspect we have a lot more borrowers who have lost borrowing power than we do borrowers who were just hoping somehow to magically flip their homes. But I could be wrong. Show me.

Posted by SelenesMom | Report as abusive

If principal reduction were indeed such a bailout to the banks, why aren’t banks clamoring for it? They are not. Principal reduction to qualified borrowers, keeps them in their home, stabilizes communities, prevents blight and loans continue to be classified as performing.

Posted by robertjstrupp | Report as abusive

@ Felix.
Even the Dallas Fed admits congress pushed Fannie Mae to buy sub-par mortgages.

Congress pushed Fannie Mae and Freddie Mac,
the de facto government-backed mortgage giants, to become the largest buyers of these specious mortgage products d/annual/2011/ar11b.pdf

Posted by Sechel | Report as abusive

@robertjstrupp It’s not clear that anyone in the banks, much less anyone at high levels, is incentivized to “keep qualified borrowers in their homes, stabilize communities, prevent blight” etc. In fact, some in the banks are likely incentivized to maximize balances (principal). Again, sure would be nice if someone had hard data to help us out with here, since I don’t expect anyone to take my wild speculation for anything other than that.

Posted by SelenesMom | Report as abusive

SelenesMom, you’ll find some data here: oneybox/2012/01/how_small_time_house_fli ppers_made_the_housing_bubble_much_much_ worse_.html

A surprising percentage of new mortgage originations at the peak were on multiple homes, nearly twice what it was as the start of the decade.

Posted by TFF | Report as abusive

Let’s take a step back for a moment, and look at the political implications, rather than fight the issue on its merits – in political terms the case has already been made and won by the opponents of bailouts for mortgage borrowers. That very issue inspired Santelli’s famous rant and the emergence of Tea Party people – literally over night – in their millions.

Placing the matter back on the front burner now could just be the thing that re-ignites the spirit of open rebellion, and could just maybe unite OWS and Tea Party into an irresistible insurgency. One can only hope – a Khmer Rouge disposition of the Wall Street types is something only likes of Danny Black would object to, isn’t it?

Posted by MrRFox | Report as abusive

File under completely predictable mark 2. Eissenger mangles a story so thoroughly that it bears no relation to what he claims it is: 3/lawler-on-possible-fannie-and-freddie. html

One should also have seen the red flag given the quote from Moodys that maybe possibly up to 500,000 homes might make sense for. Put differently that is for significantly more than 90% of cases it won’t help. So after all the arguments over whether it makes sense morally or not, the real question boils down to whether taxpayers want to subsidise yet more losses at Frannie. Note these are actual losses not the “losses” that people keep insisting got socialised at investment banks in the US

Posted by Danny_Black | Report as abusive

“And there are many career public servants, up to and including Tim Geithner, who can’t stand DeMarco and who think he is being deliberately obstructionist here.”
Mr Felix, it is hilarious the kind of public servant you are invoking to show Mr. DeMarco as obstructionist. Tim Geithner, after all, overrode all objections inside the Treasury and the Fed and forced AIG to pay all CDS contracts in full to all the Wall Street banks even though AIG could have negotiated to pay much less. That was a backdoor bailout Tim Geithner is directly responsible for. And it was the tax payers that got stuck with the bill.
How can anyone (other than you) just trust in Tim Geithner that this not another instance in which he is trying to get Wall Street another bailout at the tax payer’s expense?

Posted by EastCoastGuy200 | Report as abusive

eastcoastguy200, what objections?

Posted by Danny_Black | Report as abusive