Taxpayer-owned mortgage giant Fannie Mae is targeting families by going after struggling homeowners who strategically default on their mortgage, the firm announced Wednesday.
A default is considered strategic when homeowners have the capacity to pay, yet choose to walk away from their mortgage. The trigger, researchers say, is negative equity: When the value of a home is less than what the lender is owed on it, borrowers are more likely to strategically default.
About 11.3 million homeowners with a mortgage, or 24 percent, owe more on their mortgage than the home is worth, according to real estate research firm CoreLogic. Another 2.3 million have less than 5 percent equity in their homes. All told, about 29 percent of all homeowners with a mortgage are either underwater or very close to it. The firm estimates that the typical underwater homeowner won't return to positive equity until late 2015 or early 2016.
And Fannie Mae, an arm of the federal government and a big part of the Obama administration's housing policy, wants to make sure that if struggling families walk away, they suffer for it.
Homeowners who strategically default or did not work "in good faith" to avert foreclosure through other means will be ineligible for new Fannie Mae-backed mortgages for seven years. The firm said it will also pursue homeowners in court, seeking so-called "deficiency judgments" to recoup outstanding debt by seizing borrowers' other assets. Thirty-nine states do not limit the ability of lenders to recover what they're owed.
Fannie Mae said that next month the firm "will be instructing its servicers to monitor delinquent loans facing foreclosure and put forth recommendations for cases that warrant the pursuit of deficiency judgments."
"Walking away from a mortgage is bad for borrowers and bad for communities and our approach is meant to deter the disturbing trend toward strategic defaulting," Terence Edwards, Fannie's executive vice president for credit portfolio management, said in a statement.
Strategic defaults among homeowners have been on the rise. More than a million homeowners went that route last year, nearly double the amount in 2008 and more than four times the level in 2007, according to a recent analysis by the credit reporting company Experian and Oliver Wyman, a management consulting firm. A study by a team of academics from the University of Chicago and Northwestern University estimated that nearly a third of home mortgage defaults in March were strategic. The deeper underwater homeowners are, the more likely they are to walk away from their mortgage, the researchers noted.
Earlier this month, the House of Representatives passed a bill barring strategic defaulters from obtaining home mortgages backed by the Federal Housing Administration. The agency guarantees nearly one in four new mortgages.
"I can't help but notice that every group now frantically calling for tough penalties for homeowners who walk away was virulently opposed to judicial modification of mortgages in bankruptcy," Rep. Brad Miller, a North Carolina Democrat, told the Huffington Post.
Bank of America and Citigroup, the nation's largest and third-largest banks by assets, respectively, support changing existing law to give federal judges the power to modify mortgages in bankruptcy, otherwise known as "cramdown." Proponents argue that if homeowners were able to modify their mortgages in bankruptcy, the number of strategic defaults would substantially decrease, if not nosedive.
About 3 million homes will receive foreclosure notices this year, real estate research firm RealtyTrac estimates. More than 1 million will be repossessed by lenders, adding to the nearly 2.2 million homes that lenders took over from 2007 to 2009.
Fannie Mae and its sister firm Freddie Mac guarantee nearly three out of every four new mortgages, according to leading industry publication Inside Mortgage Finance. The two firms control about $5.5 trillion in home mortgages, according to their federal regulator. That's nearly half of all outstanding mortgage debt in the U.S. Their share of the mortgage market is nearly double what it was 20 years ago.
Because Fannie controls such a large portion of new mortgage issuance, the freezing out of homeowners for seven years could prove devastating.
Brent T. White, a law professor at the University of Arizona, recently wrote in an academic paper that most homeowners can recover from a foreclosure within two years. In fact, defaulting on a mortgage is not as bad as most people think, White notes.
"Lenders are unlikely to pursue a deficiency judgment even in recourse states because it is economically inefficient to do so; there is no tax liability on 'forgiven portions' of home mortgages under current federal tax law in effect until 2012; defaulting on one's mortgage does not mean that one's other credit lines will be revoked; and most people can expect to recover from the negative impact of foreclosure on their credit score within two years (and, meanwhile, two years of poor credit need not seriously impact one's life)," he writes.
There is a "huge financial upside" for seriously underwater homeowners to strategically default on their mortgages, White said.
While it's still taboo among most homeowners, it's common behavior among corporations.
In December, Morgan Stanley, the nation's sixth-biggest bank by assets, walked away from five San Francisco office buildings the $820-billion firm purchased as part of a landmark $2.43-billion deal near the height of the real estate boom. A group led by Tishman Speyer Properties gave up a 56-building apartment complex in Manhattan in January after defaulting on some $4.4 billion in debt. A spokesman for the California Public Employees' Retirement System, the nation's biggest municipal pension fund and one of several investors in the venture, told the Huffington Post that they "basically walked away from it."
Fannie was effectively nationalized in September 2008. Taxpayers own 79.9 percent of Fannie and Freddie. The Obama administration announced on Christmas Eve that it would provide unlimited financial assistance to the firms, disregarding what was a $400 billion cap on taxpayer bailouts. Their debt is backed by the U.S. government.
The two firms, facing growing losses on sour mortgages in perhaps a worsening housing market, have already taken $145 billion from taxpayers. Fannie Mae is responsible for $83.6 billion of that bailout.
Freddie Mac did not say it would take a similar position on strategic defaulters.
"Such so-called strategic defaults, once rare, are now common enough to jeopardize the already-weak housing and mortgage markets," wrote economists Celia Chen and Cristian deRitis of Moody's Economy.com in an April 13 note. "If the trend continues, strategic defaults could both accelerate the pace of home foreclosures and also make it harder for new borrowers to obtain mortgages. Both factors would in turn worsen the decline in house prices."
JPMorgan Chase, the nation's second-largest bank by assets with more than $2.1 trillion, warned investors last month that underwater homeowners may not continue to make their payments even when they're able to, according to a May 10 filing with the Securities and Exchange Commission.
A top executive at Freddie Mac posted a note on the firm's website pleading with homeowners to not intentionally walk away from their homes.
"Knowing the costs and factoring in the time horizon, some borrowers have made the calculation that it is better to purposely default on the mortgage. While I understand how that might well be a good decision for certain borrowers, that doesn't make it good social policy," Freddie Executive Vice President Don Bisenius argued in a May 3 note.
The firm warned investors and analysts about the risk of increased strategic defaults in March 2008. Referring to it as "ruthlessness," Dick Syron, Freddie's former chairman and CEO, said the firm was "seeing an increase in ruthlessness" that had "the potential for changing consumer behavior."
Fannie Mae said Wednesday that borrowers who have "extenuating circumstances may be eligible for new loan in a shorter timeframe" than the seven-year period it's warning about.
Republicans in the House recently tried to rein in the twin mortgage giants. Rep. Darrell Issa, the top Republican on the House Committee on Oversight and Government Reform, attempted Wednesday to amend the financial reform bill under consideration by the House and Senate to mandate that the federal government appoint an inspector general to oversee Fannie and Freddie. The mortgage behemoths' federal regulator has been operating without an independent watchdog looking over it and Fannie and Freddie since 2008.
Republicans have also tried to amend the bill to subject Fannie and Freddie to the Freedom of Information Act so members of the public can keep tabs on the firms by compelling the disclosure of documents and records.
Both efforts were thwarted by House Financial Services Committee Chairman Barney Frank (D-Mass.), who ruled that they were not "germane" to the legislation under consideration.
Emails sent after normal business hours to spokesmen for the White House and Treasury Department requesting comment were not returned.
Ryan Grim contributed reporting.