Counterparties: DeMarco’s principal principle
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The most hotly debated cure for America’s gigantic and protracted foreclosure crisis is all about principal – or rather, principle. The idea behind principal reduction is straightforward: Instead of valuing a struggling borrower’s mortgage at its original value, you reduce the amount to something closer to the market value. That, the argument goes, lowers the borrower’s payments and makes him or her all the more likely to stay in that home.
The business press jumped yesterday when it seemed that Ed DeMarco, head of the FHFA (Federal Housing Finance Agency), the regulator that oversees Fannie and Freddie, seemed finally to change his principles on principal reduction. The American Banker this morning was rightly skeptical – DeMarco in fact only opened himself to discussing the topic. DeMarco’s argument against principal reductions is that they could trigger “strategic defaults.” Of course, this moral hazard argument is somewhat ironic coming from the regulator of taxpayer-owned Fannie and Freddie.
It’s unfortunate that DeMarco, who has taken a huge amount of criticism for his intransigence on mortgage modifications, trotted out this tired logic. Although calling him “America’s most dangerous man” is going a bit far, DeMarco’s speech (and accompanying presentation) was deeply disappointing in its focus on the bogeyman of “strategic modifiers”:
One factor that needs to be considered is the borrower incentive effects. That means, will some percentage of borrowers who are current on their loans, be encouraged to either claim a hardship or actually go delinquent to capture the benefits of principal forgiveness?
As Nick Timiraos points out, DeMarco’s model shows the taxpayer savings from principal reduction are lost if from 1 percent to 5 percent of homeowners who are underwater but not delinquent strategically default. HUD Secretary Shaun Donovan, however, says “the vast majority of homeowners don’t operate that way.”
After decades of Americans hearing the benefits of homeownership from all angles, it’s hard to believe that a Fannie-Freddie principal reduction program would lead to a wave of people defaulting. There’s some evidence that strategic default isn’t all that big a problem and may actually be declining. There’s even a whole genre of media profiles that chronicle just how difficult and painful it is for homeowners to decide to walk away from their homes.
But strategic defaults continue to scare DeMarco, just as they do Rick Santelli and Dick Bove. DeMarco’s tone is obviously different, but the vision of the American homeowner as the post-crisis welfare queen is the same.
It’s true that we don’t have good data to know precisely how homeowners will react to a principal reduction program at Fannie and Freddie. But if a principal reduction plan is, as DeMarco says it is, an argument about “which tools, at the margin” make a difference, why not give it a go? Bank of America, for one, is trying a variation of it.
It’s a strange day when a key regulator hews closer to the views of TV pundits than the Treasury Secretary. – Ben Walsh
And on to today’s links:
Shock! There are more efficient ways for the government to collect taxes – NYT
Publishers caught conspiring in “upscale Manhattan restaurant” – MoJo
Why banks aren’t lending more – Bonddad Blog