Federal Housing Finance Agency (FHFA) acting Director Edward J. DeMarco recently indicated that relief from the federal government for low- and moderate-income homeowners with stretched mortgages may soon be on the way.
Challenged with minimizing taxpayer losses while maximizing assistance to homeowners, DeMarco has taken flack for refusing to allow the Government Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac to offer mortgage holders a reduction on principal, focusing instead on borrower assistance programs.
However, in a Brookings Institution presentation April 10, DeMarco said a Department of the Treasury offer of Troubled Asset Relief Program (TARP) funds had changed the equation. Updated analysis from the FHFA indicated principal forgiveness could lower the foreclosure rate and save Fannie Mae and Freddie Mac $1.7 billion.
“TARP funds, up to now, have never been used for any Fannie and Freddie loan modifications, but the Treasury Department has determined—for the first time this January—that if we were to do principal forgiveness modifications … it would use TARP money [for] Fannie and Freddie as investors, to receive the investor incentive payment.” he said.
The relief measures are targeting a percentage of “underwater” mortgages—loans that have balances higher than the fair market value of the home. According to DeMarco, there are currently an estimated 11 million U.S. homeowners suffering from underwater mortgages, 2.5 million of which are on the GSEs’ books.
He noted the hardship faced by struggling homeowners following the collapse of the U.S. housing market. Many homeowners had not made risky investments, he said, but had gone underwater even after making sizable down payments and working two jobs.
“No one can look at the dislocations in the housing market and not feel frustration at how so many people and institutions failed us, whether through incompetence, indifference, or outright greed or fraud,” he said.
According to First American CoreLogic data, U.S. housing prices dropped by an average of 21 percent between 2006 and 2009, with some states exhibiting greater price falls and little upside since then.
“Virtually every homeowner in the country has suffered a loss,” DeMarco said, noting that housing wealth in the United States had declined by $7 trillion from the end of 2005 through 2011.
While the Treasury’s offer makes principal forgiveness more appealing, DeMarco noted that those eligible were comparatively small—around 1 million households compared to the 11 million underwater homeowners.
A key risk in principal forgiveness, he noted, was the potential incentive for current borrowers to cease paying mortgages in search of their own principal forgiveness loan modification.
The majority of Americans continue to pay their mortgages, DeMarco noted, adding that preventing foreclosures and keeping homeowners paying their mortgages in a manageable way were critical to recovery.
“Encouraging their continued success could have a greater impact on the ultimate recovery of housing markets—and cost to the taxpayers—than the debate over which modification approach offered to troubled borrowers is preferable,” he said.
He outlined a number of improved strategies within the GSEs’ loan assistance programs, including loan modifications to reduce monthly payments, temporary assistance for those with short-term difficulties, and short sales, where the unpaid balance on the mortgage is forgiven.
He was particularly upbeat about ‘principal forbearance,’ a form of ‘shared appreciation’ that sets aside the borrower’s loan principal, charges zero interest on it, and has no demand for repayment until the time of sale.
“It lets it sit there, but down the road if the loan modification is successful, then the borrower retains that obligation to pay off that forborne principal amount at the time they sell their house.”
Should there be an upswing in the market at the time of sale, the mortgage is paid back to the taxpayer through the GSEs, an option that would not occur through principal forgiveness, and the homeowner could make a possible gain.
“Principal forbearance has become an important part of loan modifications for underwater borrowers,” he said, “increasing from 11 percent of total modifications in 2010 to 26 percent in 2011.”
Speaking at the Brookings event, Mark Fleming, chief economist for CoreLogic, said that with the housing recovery projected to take years, he was concerned about the willingness of homeowners to stay in loan assistance programs—particularly as house values were so far below homeowner mortgages.
“This is a problem that’s not just about dealing with those who are struggling and delinquent, but more broadly, negative equity is a problem for … a quarter of all homeowners out there.”
Foreclosures in the United States numbered around 800 to 900 thousand last year, he said, and while that was an improvement from 1.1 million about 2 years ago, he wondered about the long-term effects.
“What are we going to do about those who have behaved exactly as we wanted, paid those mortgages, but yet 5, 6, 7, 10, 12 years from now are still underwater?” he asked.
Paul Nikodem, executive director and head of mortgage credit research at Nomura Securities International, said their research indicated rental costs as a factor.
“We find that modified subprime borrowers are paying about 10 to 20 percent less than the equivalent rent in those cities,” he said. “If rents are growing—call it 3 to 5 percent a year—this only provides a greater disincentive for borrowers to default in some ways if they think about what they would have to pay in rent after they get kicked out of their homes,” he said.
Tony Sanders, professor of finance in the School of Management at George Mason University, encouraged DeMarco to do more research, saying loan modifications and forbearance programs were a priority.
“Principal reduction should be the absolute reduction of last resort, he said.
Director DeMarco said it was time for the issues to be sorted out, and would be looking to “wrap it up in the next few weeks.”