Below the Fold: Ed DeMarco Should Do His Job -- It's a Matter of Principal

A wrap-up of stories and posts you might have missed or overlooked -- the ones below the fold.

Acting Federal Housing Finance Agency (FHFA) Director Ed DeMarco has not been shy about letting underwater homeowners sink. This week, he made it painfully clear that despite the Administration calling for principal reduction, he would have no part of it. His reasoning appears to be more out of contempt for borrowers and the minions whose loans are held by Fannie and Freddie Mac than any legitimate business or accounting decision.

Since 2008, DeMarco has run the FHFA as an independent regulator of the now government (and taxpayer) owned Fannie Mae and Freddie Mac. Over the past year DeMarco has been under pressure by liberal advocates, congressman, and journalists to use his position and authority to help struggling homeowners.

In March of this year, Rep. Barney Frank called DeMarco "rigid" in The Hill and chastised DeMarco for the way he's running the agency:

He's acting as if he was head of two private companies called Fannie and Freddie and not taking into account the impact this has on the economy, and I think he should be more cooperative with efforts to reduce foreclosures.

By refusing to implement a principal reduction program, FHFA is turning it's back on hundreds of thousands of underwater homeowners and costing taxpayers billions of dollars. Principal reduction would not only help struggling families stay in their homes, it would also stabilize housing markets and bring much needed relief to communities that have been hit the hardest by the housing crisis. I introduced the Preserving American Homeownership Act to force FHFA to give thousands of underwater homeowners the option of principal reduction and I'm going to keep fighting to get it done.

Peter Goodman of Huffington Post wrote a scathing piece about DeMarco, calling him the single largest obstacle to a meaningful recovery.

If DeMarco were fire chief and your house became engulfed in flames, you could forget about calling 911. By his reasoning, the taxpayer would be best served by keeping the fire engines in the station, lest they get damaged in the line of duty. It would not matter whether the flames licking your windows were the result of your recklessness or the product of an explosion at, say, the methamphetamine lab down the street. He would not run up the municipal water bill by saving your block.

Even Republican (and international gaffer) Mitt Romney is on board with similar plans that have been proposed to DeMarco. Glenn Hubbard, Romney's chief economic adviser who also served as President George W. Bush's chief economist proposed plans that would reduce monthly payments:

Hubbard is an advocate for using Fannie Mae and Freddie Mac to set off a nationwide wave of mortgage refinancing. In a paper co-authored with Columbia economist Christopher Mayer, Hubbard estimates that more than 75 percent of the homeowners with 30-year mortgages backed by Fannie or Freddie are paying interest rates higher than 5 percent. But for the past two years, interest rates have been closer to 4 percent. That means tens of millions of Americans are paying more than they need to every single month.

Or, as was also proposed, he could have let Fannie and Freddie borrowers use the Treasury's principal reduction plan, HAMP, resulting in homeowners paying interest on less mortgage.

On Tuesday, in a one page, two paragraph, 204 word letter, he rejected that option:

After extensive analysis of the revised HAMP PRA, including the determination by the Treasury Department to begin using Troubled Asset Relief Program (TARP) monies to make incentive payments to Fannie Mae and Freddie Mac, FHFA has concluded that the anticipated benefits do not outweigh the costs and risks. Given our multiple responsibilities to conserve the assets of Fannie Mae and Freddie Mac, maximize assistance to homeowners to avoid foreclosures, and minimize the expense of such assistance to taxpayers, FHFA concluded that HAMP PRA did not clearly improve foreclosure avoidance while reducing costs to taxpayers relative to the approaches in place today.

Treasury Secretary Tim Geithner followed up with an eight page public letter, accompanied by a five page memorandum in which Treasury staff lays out their case for principal reduction. In the letter Geithner argues that allowing principal reduction would ultimately save taxpayers as much as $1 billion.

I do not believe it is the best decision for the country because, as we have discussed many times, the use of targeted principal reduction by the GSEs would provide much needed help to a significant number of troubled homeowners, help repair the nation's housing market, and result in a net benefit to taxpayers.

Geithner, probably refraining from saying, "Now you're just making stuff up," referred to the FHFA's numbers as "selective" and pointed out that the agency's own analysis "has shown that permitting the GSE's to participate in the program could help up to half a million homeowners and save the GSEs $3.6 billion compared to standard loan modifications.

Geithner ends his letter with an uncharacteristic and surprisingly empathetic tone:

Five years into the housing crisis, millions of homeowners are still struggling to stay in their homes, and the legacy of the crisis continues to weigh on the market. You have the power to help more struggling homeowners and help heal the remaining damage from the housing crisis. I hope you will move to address these problems with a sense of urgency and force commensurate with the scale of the remaining challenges.

So what's DeMarco's problem? Moral Hazard and his aforementioned apparent contempt for the common man. According to DeMarco if he were to allow principal reduction, interest reduction, or even start handing out vouchers for a free hot dog at the ball park, homeowners everywhere would suddenly leap into action (or inaction) and all go into default. He also argues that it would cost taxpayers money.

There are a couple of problems with DeMarco's logic, aside from the painfully obvious ones, one of the more glaring being that he's starting to appear like little more than a civil servant hack with delusions of grandeur.

There are plenty of ways to avoid the "moral hazard" of homeowners suddenly revolting against mortgage payments in an effort to get a free house. More to the point there's little evidence to support DeMarco's fear that homeowners will suddenly stop paying their mortgage. In fact, following the recent $25 Billion AG settlement, credit rating agency Fitch saw no signs of strategic default rising. Housingwire wrote in a July article:

Fitch views strategic defaults as an ongoing concern. That said, there does not appear to be any sign yet of a material change in the behavior of underwater borrowers attempting to strategically default to qualify for a reduction.

Another obvious solution, but seemingly out of DeMarco's grasp is a simple, yet effective, cutoff date. Laurie Goodman of Amherst Securities recently offered one simple solution: Make it a one-time program open to borrowers that are already delinquent when the program begins. This would limit the borrower's ability to default intentionally just to be eligible. Too easy? How about some skin in the game? John Griffith and Jordan Eizenga writing for suggest shared appreciation:

To maximize returns to Fannie and Freddie, we propose a pilot program that reduces principal--often by as little as 5 percent or 10 percent--without creating skewed incentives for borrowers. Through so-called "shared appreciation" modifications, Fannie or Freddie agrees to write down a portion of the principal on deeply underwater loans in exchange for a portion of the future appreciation on the home. The borrower has a reason to keep paying, while the lender benefits when home prices eventually stabilize and rebound.

Since the borrower has to give up a meaningful share of future home price appreciation, basically establishing a cost for program participation, the shared appreciation modification is not particularly attractive to borrowers that don't need it. And by phasing in the principal reduction--say, over the course of three years contingent on meeting every monthly payment--the borrower has additional incentive to stay current on their mortgage. Both of these program rules deter borrowers from defaulting on their loan just to get a reduction in principal, what some critics call the "moral hazard" problem.

So really, the moral hazard argument, which seems to be the only one DeMarco is going with, also assumes that homeowners can default at little or no cost - hence the contempt. Delinquencies affect credit scores, cause stress, and can still end in foreclosure despite any well laid plans - there's always a risk.

It's not as if any of this is news to DeMarco. Back in June, Rep. Gary Peters along with two other congressmen introduced "The Preserving American Homeownership Act of 2012," a thoughtful and cogent solution to DeMarco's arguments. "This legislation offers homeowners that meet certain criteria the opportunity to repay and remain current on their loan, which would prevent Fannie Mae and Freddie Mac from incurring additional losses," Peters said.

The bill offers a pilot program for struggling homeowners with Fannie and Freddie loans and a trial period:

The Preserving American Homeownership Act directs the FHFA and FHA to create a principal reduction pilot program. Where principal reduction would result in a net present value gain for taxpayers, the homeowner would be eligible for an immediate reduction in principal to a loan to value (LTV) ratio of 115%. If the homeowner continues to make payments for three years additional reductions would be phased in resulting in a LTV ratio of 95%. In order to be eligible for a principal reduction, the homeowner would have to be in danger of foreclosure and so deeply underwater that other remedies, such as principal forbearance, interest rate reduction, or term adjustment will not be enough to give the homeowner an affordable monthly payment.

The bill, as the press release on Peters' website points out is a bipartisan effort to give relief to underwater homeowners. "Too many Americans, including thousands in Minneapolis, have been dealing with this housing crisis for six years with little relief," said Rep. John Campbell (R-CA) who co-authored the bill along with Keith Ellison (D-MN). "Any homeowner whose house is 'underwater' is struggling and this bill could give them a clean slate. This bill would let families keep their homes and let investors preserve their investment, which would be fair to families, good for our communities, and would contribute to our economic recovery."

There's even mention of a shared appreciation model, making it painfully obvious that FHFA would stand to benefit from the plan:

Losses to taxpayers are further reduced by requiring homeowners to share in any future appreciation. If the borrower sells their home or refinances their mortgage he or she is required to share up to 50% of any appreciation in value to offset the cost of the principal reduction.

With plenty of support from the public, congress, journalists, economists, and the Administration, DeMarco's push back seems more like a spoiled child's tantrum as opposed to simple ignorance on the part of a life long civil servant with an axe to grind.

This isn't simply about underwater homeowners and "responsible borrowers" looking down their noses at people in trouble. This about the economy at large. As the article, "Why is Ed DeMarco Blocking a Win-Win Housing Program?" in Time points out:

Even if you're not an underwater homeowner, this pertains to you because American taxpayers -- through the government's conservatorship of Fannie Mae and Freddie Mac -- own or guarantee roughly 60% of the outstanding mortgages in America. So if proponents of principal reduction are correct, implementing such a plan through Fannie and Freddie would save taxpayers money, help out struggling homeowners, and stimulate the broader economy.

The simple fact is, that there's a very good chance the foreclosure crisis could get worse as almost 60 percent of the nation's largest metropolitan areas saw increased foreclosure activity in the first half of 2012, according to a recent report from foreclosure information website RealtyTrac, and cities are being destroyed by foreclosures.

DeMarco seems to be gladly taking on the role of, as my dad used to say, a pimple on the ass of progress, and should be more concerned with actual mandates of his job. Under the statute creating the FHFA, that job is to protect Fannie and Freddie's finances and to ensure that they are "in sound and solvent condition," not to prevent net losses of taxpayer money.

Even if it were his job to preserve taxpayer money, it's not even clear if he's correct in that assessment. As Paul Krugman points out in a piece calling for DeMarco's firing, simply titled, "Fire Ed DeMarco" DeMarco's analysis fails to take into account the benefits of economic growth potentially realized by Fannie and Freddie resulting from the plan:

That's a very arguable point even on its own terms, because the paper he cited (pdf) in support of his stance took no account of the positive effects on the economy of debt relief -- even though those effects are the main reason for offering such relief. Since a reduction in debt burdens would strengthen the economy, this would mean greater revenue -- and this might well offset any losses from the debt forgiveness itself. Furthermore, even if there's a small net cost to taxpayers, debt relief is still worth doing if it yields large economic benefits.

Krugman goes on to argue and point out just who DeMArco is working for here:

In any case, however, deciding whether debt relief is a good policy for the nation as a whole is not DeMarco's job. His job -- as long as he keeps it, which I hope is a very short period of time -- is to run his agency. If the Secretary of the Treasury, acting on behalf of the president, believes that it is in the national interest to spend some taxpayer funds on debt relief, in a way that actually improves the FHFA's budget position, the agency's director has no business deciding on his own that he prefers not to act.

Americans are a hearty and hopeful lot and DeMarco may be counting on that, but the situation doesn't appear to be getting better any time soon. If the housing market doesn't improve, unemployment keeps rising, and life continues to happen in the form of divorce, illness, bills, taxes, etc., strategic default may begin to look like the light at the end of tunnel. Then we'll see how sanctimonious DeMarco can afford to be.