The director of the Federal Housing Finance Agency (FHFA) announced today that with additional incentives, funded through TARP, a program of principal forgiveness through Fannie Mae and Freddie Mac, the Government-Sponsored Enterprises (GSE), might now make more sense.
While making no official announcement, FHFA Director Edward DeMarco said that the additional funds would make such a program more cost effective for taxpayers and therefore more acceptable to enact. However, he maintained a number of reservations, noting that further analysis is being conducted on the operational costs and borrower incentive effects of such an endeavor.
Whether losses are absorbed on the balance sheet of the GSEs or TARP, a program of principal forgiveness will cost money. DeMarco pledged transparency in determining those costs.
DeMarco highlighted the mere operational challenges of devising a program that will require standardized guidelines for more than 1,000 mortgage servicers. Apart from that, he expressed significant concern that this will encourage underwater homeowners who are current on their mortgage payments to strategically default on payments in order to qualify for such a program.
Principal forgiveness is designed to reduce the amount still owed on a loan by the monetary difference between the amount owed and the lower home value, the underwater portion. This results in a loss to the investor or holder of the mortgage, though it may help the borrower avoid default and have positive market effects overall. In comparison, principal forbearance sets aside the underwater portion of the loan to be repaid later, remaining interest free until repayment may begin. This reduces borrower’s monthly payments while not directly resulting in a loss for the investor unless the borrower defaults later.
There was considerable debate in the panel following DeMarco’s speech on the effect that this could have on the housing market and economy in general. With full participation, DeMarco expected the number of eligible borrowers to be slightly less than 700,000. With an estimated 11 million underwater borrowers, many with private label backed mortgages, such a program would only reach a fraction of underwater borrowers.
If DeMarco announces a new policy for loan forgiveness in the coming weeks, it seems certain that the policy comes not because he thinks it to be the best or most appropriate way to fix the housing market, but because he personally finds it difficult to expand his congressional mandate to mitigate all losses to taxpayers. He has been pressed both by the Obama Administration and especially Senate Democrats, a number of which have called for his resignation or termination.
Regardless, the unprecedented nature of the housing bubble and financial crisis will leave the effectiveness of many of these programs in doubt for years to come and the Obama Administration has done little to diminish market uncertainty. The only way to fix the housing market is to grow the overall economy. As DeMarco reiterated in his speech today, a government-backed program for principal forgiveness will not be the silver bullet. Jobs and higher incomes will drive an economic demand for housing and recoup the massive losses in home equity sustained over the last few years. Only a comprehensive growth-oriented agenda can move the housing market in the right direction.