By Preeti Vissa
May’s drop in new home sales is just the latest sign that the housing market continues to be bleak, as it has every right to be with a “shadow inventory” of 1.7 million impending foreclosures hanging over it. But there is some good news: Discussion of the need for more aggressive foreclosure relief, including reducing the principal of troubled loans, is heating up. While attention to an issue isn’t a guarantee of meaningful action, it’s a necessary prerequisite, so the fact that people are talking about this is a happy development.
The bad news is that there are lots of obstacles in the way of principal reduction happening on a large enough scale to actually do some good.
One of the biggest is the investors who actually own the bulk of mortgages. They, not the banks, call the shots in a great many cases.
Huge players in this field are Fannie Mae and Freddie Mac, the theoretically private but government-backed mortgage giants that the federal government took over a couple years ago at the height of the housing collapse, and which are still 79 percent owned by taxpayers. The two companies own or back about half of all U.S. mortgages, including a massive number of troubled loans that are in danger of foreclosure.
The Federal Housing Finance Administration, which oversees Fannie and Freddie, has refused to back a principal reduction program for their loan portfolio based on incredibly short-sighted reasoning: The agency seeks to minimize losses to taxpayers in the short term, and writing down these mortgages would shrink the theoretical value of their loan portfolio. In the short run, loan modifications would appear to reduce the return on taxpayers’ investment, so FHFA is saying no.
What’s missing from that line of thinking is the effect on the overall economy. An effective principal reduction program would help families keep their homes, stabilize the floundering housing market and put cash in the pockets of millions of Americans through reduced mortgage payments – money they could spend on other goods and services, helping to jump-start the economy.
Some in Washington have begun to see that FHFA’s attitude is short-sighted and ultimately self-defeating. In March, 54 Democratic members of Congress – including some of the party’s most prominent names — wrote to FHFA acting director Edward DeMarco asking him to reconsider:
FHFA’s opposition to modifying [Fannie's and Freddie's] mortgages by reducing principal is greatly increasing taxpayer losses, however. Foreclosures result in a loss of 70 percent or more on the mortgage, and claims against homeowners for the difference, even in jurisdictions that allow such claims, are usually worthless. Sustainable mortgage modifications that avoid foreclosure will almost always reduce the loss to the enterprises.
More recently, former White House economist Jared Bernstein joined the call, saying, “They want to protect their book, which is the American people’s book. But I don’t think it’s a good strategy for the economy. Housing is still an albatross hanging over the economy. You can’t get the escape velocity you need with 1 million foreclosures.”
That respected voices like Bernstein are joining the chorus can only help. Another source of possible leverage is the ongoing negotiation between state attorneys general and the five largest loan servicers as they attempt to work out a settlement for the assorted misdeeds that plagued the mortgage market in recent years. At least some of the money the AGs wring out of these institutions may go to principal reduction, according to recent reports. But this may be optional for the states, and some AGs, who seem unclear about whom they work for, oppose principal reduction.
The AGs should hang tough, and get as much as they can to be put into real relief for struggling homeowners. And FHFA should rethink its position and remember that ultimately the best thing for all – including Fannie, Freddie and U.S. taxpayers – is a healthy housing market that can come off life support. And that won’t happen with 1.7 million impending foreclosures hanging over the market.