Our guest blogger is John Griffith, a policy analyst with the economic policy team at the Center for American Progress Action Fund.
There’s a growing consensus that more principal reduction — the writing off of a portion of an underwater mortgage in exchange for a higher likelihood of repayment — can help avoid another wave of costly and economy-crushing foreclosures. But the country’s two biggest mortgage companies are not convinced.
Fannie Mae and Freddie Mac (the GSEs), both under government conservatorship since 2008, have yet to embrace principal reduction as a viable foreclosure mitigation tool. In fact, the mortgage giants are forbidden from lowering principal on any loans they own or guarantee by their regulator, the Federal Housing Finance Agency, or FHFA.
We think it’s time for Fannie, Freddie, and FHFA to rethink that position. Here’s the basic argument in a new report.
Reams of economic evidence show that principal reduction is often the most cost-effective way to avoid unnecessary foreclosure, especially when a borrower is deeply underwater — owing significantly more on their mortgage than their home is worth — and facing a long-term economic hardship. That’s because reducing principal is the only way to rebuild an underwater borrower’s equity while permanently lowering monthly mortgage payments.
Fewer foreclosures help more than just struggling homeowners. Local housing markets are better off, as each foreclosure decreases the value of every other home in the neighborhood. And since the average foreclosure costs more than $50,000 to the lender or investor, avoiding default often helps the books of Fannie and Freddie, which in turn benefits every taxpayer on the hook for their losses.
So while principal reduction will give more struggling homeowners a fighting chance at staying in their homes, this is not a matter of charity. It’s good business. That’s why roughly one in four modifications on bank-held loans involved some principal reduction in the last quarter of 2011, according to data released yesterday by the Office of the Comptroller of the Currency.
Fannie, Freddie, and, FHFA are aware if this, of course. In fact, the FHFA’s own analysis shows that reducing principal on all deeply underwater GSE-backed loans — about 1.4 million mortgages altogether — would save the enterprises and the taxpayers supporting them approximately $20 billion over the life of those loans compared to not doing anything.
And we expect those gains to be even higher today, after the Obama administration announced new incentives for Fannie and Freddie to write down principal through the Home Affordable Modification Program, or HAMP. Indeed, recent reports and statements from top brass at Freddie indicate the GSEs may be warming to the idea of principal reduction.
Despite all of this evidence, FHFA is still hesitant to deploy principal reductions, instead relying on other loan modifications that they (falsely) believe reduce taxpayer risk. (With FHFA’s goal of maximizing returns to taxpayers in mind, we offer a possible solution in our report.)
To be sure, a principal reduction pilot will not be a silver bullet to our housing woes. But the painful reality is that we’re a long way from the end of the crisis, and millions of GSE-backed loans are still at serious risk of foreclosure today. Fannie, Freddie and their regulator need to keep all options on the table.