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The Possibility of Home Loan Principal Reductions

Monday, March 26, 2012 2:12pm
Principal Reduction
Imagine a solution to the housing crisis that would keep hundreds of thousands (if not millions) of home loan borrowers in their homes, bring their monthly payments to manageable levels, lessen the stress on taxpayers, and, to top all of this off, save mortgage lenders money. This “imagined scenario” really sounds like a farfetched dream that takes the best of both worlds and combines them together in a utopian solution.

But what if this wasn’t imagined, and instead a real possibility? According to a recent report by ProPublica, such a possibility is within grasp.

There’s just one problem: some higher-ups won’t allow it.

Some Dreams May Come True

The imagined scenario pitched above is a nationwide principal reduction of all underwater home loans. Just the mere thought of such a plan makes even liberals lift a skeptical eyebrow (let alone their conservative counterparts), but according to a new analysis by Freddie Mac and Fannie Mae themselves, home loan forgiveness may very well be the most profitable course of action.

The analysis, which has yet to be made public, has concluded that, contrary to popular belief, home loan principal reductions would not only be best for homeowners, but they would also save Freddie and Fannie money.

A reduction of principal on underwater mortgages would allow countless families to retain their home. Additionally, it would allow Freddie, Fannie, and other lenders to stop their foreclosure procedures which can amount to extraordinary costs, as some filings take months, if not years, to complete. Finally, the burden that has been placed on every taxpayer in the nation to make sure Freddie and Fannie remain afloat would be removed from their shoulders.

This isn’t just a dreamer’s theory that looks good on paper either. Freddie and Fannie’s analysis that’s supposedly filled with cold, hard, irrefutable numbers was just recently presented to the Federal Housing Finance Agency (FHFA), but the FHFA’s acting director is standing in the way.

Introducing Mr. Edward DeMarco

Edward DeMarco, holding a Ph.D. in Economics from the University of Maryland, was designated the acting director of the FHFA on August 25, 2009 by President Obama. As acting director, DeMarco oversees Freddie and Fannie as well as 12 other federal home loan banks.

With light blue eyes surrounded by frameless glasses, a small, round head hosting pencil thin eyebrows that are often caught on film in an upwards, a small, straight-lipped smile, DeMarco looks like a cross between Christopher Walken and a German World War II scientist. While he isn’t an actor nor a WWII super-villain, he has had a notorious history of being vehemently opposed to principal reductions, claiming that such a move would be a bad business decision that would ultimately cost the taxpayers more money.

But when asked his opinion on Freddie and Fannie’s principal reduction analysis, DeMarco refused to comment.

“As I have stated previously, FHFA is considering HAMP incentives for principal reduction and we have been having discussions with [Freddie and Fannie] and Treasury regarding our analysis, ” he later told ProPublica and NPR in a statement about the Home Affordable Modification Program (HAMP).

That comment, taken in context with one made less than a month ago, has home loan principal reduction supporters losing hope. On Feb. 28th, DeMarco told the Senate banking committee, “[Freddie and Fannie] have been reviewing principal forgiveness alternatives. Both have advised me that they do not believe it is in the best interest of the companies to do so.”

The problem with DeMarco’s statements and the supposed results from Freddie and Fannie’s analysis is that one of the two parties must be lying—or severely misinformed at best.

When Freddie and Fannie claim that home loan reductions will be better for every party involved, it’s nonsensical to believe that the two agencies would tell DeMarco that they don’t believe reducing underwater home loans’ principals is in their best interest.

What do Other Experts Have to Say?

“Principal reduction works,” Mark Zandi, chief economist of Moody’s Analytics, told ProPublica. “If someone gets a reduction in their principal amount, it gives them a real powerful hook to really fight to try to hold onto the home, even if things aren’t going financially right for them… I’m now perplexed why DeMarco is not more fully engaged [in supporting home loan principal reductions].”

But others aren’t so sure.

Anthony Sanders from George Mason University feels home loan reductions could spark a wave of defaults that otherwise wouldn’t have occurred. When homeowners see their neighbors receive a principal reduction, the homeowner who is currently paying his bill on time may be incentivized to default in order to receive a reduction as well.

Due to that, Sanders told ProPublica that “DeMarco is absolutely right.”

But before the public collectively condemns DeMarco for failing to help the country, it’s important to wait for the whole story to be released. He’s a government regulator that is supposed to have no financial interest of his own vested in his decisions, so to assume he’s intentionally out to “get” the nation is something that should be left to conspiracy theorists.

Until Freddie and Fannie release their findings, let’s enjoy the show from the side lines and hope that the powers that be have our nation’s home loan borrowers’ best interest in mind.

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