Reactions Mixed on Government’s Principal Reduction Efforts

Recent comments by Ed DeMarco have reinvigorated the debate on principal reductions.

FHFA Acting Director Ed DeMarco added spice to the principal reduction pot on Tuesday, coming out in hesitant favor of the measure for Fannie Mae and Freddie Mac loans.

Long an opponent of the policy measure, DeMarco said in comments before the Brookings Institution that using a revised study methodology, the FHFA found it could offer borrowers with principal write downs and save money at the same time, though he maintained his reservations on the program’s effectiveness.

DeMarco’s comments, according to a HousingWire article on the subject, have further split public opinion on the merit of principal reductions to stave off foreclosures, and analysts are once again debating the effects of such a plan.

Analysts at Keefe, Bruyette & Woods, for instance, said DeMarco’s comments indicated a true possibility for principal reduction policy.

“We think a change in policy to allow more principal reductions is coming but expect it will be announced later in the month,” they said.

Jaret Seiberg, however, a senior policy analyst at Guggenheim in Washington, saw the speech from the opposite viewpoint, and argued that with DeMarco’s continued preference for forbearance to stave of foreclosures, principal reduction does not have a chance.

“Post this speech, we believe it will be difficult to adopt a significant principal reduction program,” Seiberg said.

Issac Boltansky, an analyst at Compass Point, said that even with DeMarco’s objections, the matter may be out of his hands, considering the powerful players that want a principal reduction program.

“Our conversations with contacts lead us to believe that his speech has done little to relieve pressure for him to embrace principal reduction,” Boltansky said. “DeMarco is still facing considerable pressure from the White House, Treasury and a formidable block of congressional Democrats. We believe that if he refuses to adopt principal reduction as a means of foreclosure prevention that the likelihood of him being relieved of his position is extremely high.”

Beyond the political support of the program, analysts continue to debate its possible effectiveness. The American Bankers Association, for instance, said that given the potential costs of principal reduction, they do not see a future for the program.

“In most instances, principal reductions through Fannie Mae and Freddie Mac are not a feasible solution because they increase — rather than limit — taxpayers’ liability, raise the cost of credit and create improper incentives for borrowers,” the association said.

And those incentives – that homeowners who are current on their mortgage will be inspired by the program to go delinquent and earn a reduction on their mortgages principal – have DeMarco, and analysts at Bank of America, concerned.

“DeMarco expressed specific concern about keeping the remaining borrowers current on their mortgages, most of whom have always been current,” the analysts said. “He clearly expressed concern about incentivizing these borrowers to claim hardship or go delinquent on their mortgage. We conclude from his preliminary remarks on the incentive approach to principal forgiveness of GSE loans that there will be zero to minimal scale of such an approach.”

Could strategic modifiers, or, homeowners who miss payments to qualify for loan modifications, really prove so detrimental to a principal reduction program? Over at the Calculated Risk blog, writer Bill McBride was batting that idea around with Felix Salmon of Reuters.

Though the two disagreed on the number of strategic modifiers – Salmon saw their impact as minor, while McBride predicted that with strategic modifying’s impact being less than strategic defaulting, more troubled homeowners would opt for the former strategy – both were skeptical of the program’s effectiveness.

Salmon wrote, “[L]et’s try principal reductions in the real world, and see what happens. If they turn out to be incredibly expensive, then we can revisit the issue. But my guess for the most likely outcome is not a wave of strategic modifiers. Rather, it’s that the program turns out to be much like all other government attempts to deal with underwater borrowers: a damp squib where very little happens at all.”

To which McBride replied, “I think some sort of principal reduction program will be announced, with tight guidelines, but I agree with Salmon, I expect the program will have little impact.”

And in the end, it all goes back to an idea we wrote about earlier this week – are the government’s housing plans far too timid? Is a little FDR what we need to emerge from the housing downturn?

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