Edward DeMarco has opened up a new front on his war against principal reduction.
On Thursday, the Federal Housing Finance Agency, which DeMarco oversees as acting director, threatened to take action against local governments considering using the power of eminent domain to write down the value of some underwater mortgages in their communities. The move comes a week after DeMarco ruled out principal reduction on loans controlled by Fannie Mae and Freddie Mac, the bailed-out mortgage giants he effectively controls as conservator of the companies.
The Federal Housing Finance Agency "has significant concerns about the use of eminent domain to revise existing financial contracts," the agency said in a notice filed in the Federal Register. "FHFA has determined that action may be necessary on its part to avoid a risk to safe and sound operations at its regulated entities and to avoid taxpayer expense."
The notice, which includes a request for public comment on the issue, comes as a handful of hard-hit communities in Southern California, Chicago and on New York's Long Island weigh a proposal by a venture fund, Mortgage Resolution Partners, that would have them seize underwater home loans held in private mortgage trusts. The local governments would then write off that debt, and help the homeowners refinance at the new, lower price.
Though just 10 percent or so of home loans are held in private trusts, they typically include those made in the years immediately proceeding the housing bust, and are thus the most likely to be deeply underwater and in danger of failing. Estimates vary, but somewhere around one quarter of all borrowers in the United States owe more on their home loans than they are worth. In the communities weighing the plan, including San Bernardino County, Calif., the percentage of underwater borrowers is close to 50 percent.
Officials in San Bernardino and Chicago could not be immediately reached for comment on the FHFA's warning about the proposal, but John Vlahoplus, chief strategy officer at Mortgage Resolution Partners, characterized the move "as another attempt by a bond holder trying to use its position to stop local governments from fixing the crisis."
Fannie Mae and Freddie Mac purchased private-label home loan bonds in the run-up to subprime crash, just like other investors. Fannie and Freddie, and by extension DeMarco, therefore have no greater say over what happens to these loans than any other bondholder that made an investment, Vlahoplus said.
"You cannot by dint of being an investor in a private entity control that entity," Vlahoplus said. "They made a bad deal, invested in these securities and the loans fell in value. The right approach is to go to court, but they know they will lose in court."
FHFA did not immediately return a request for comment for this article.
It's not clear what kind of action the agency might take if it decides to intervene in preventing local governments from using eminent domain to seize mortgages. That seizure would happen through a court action, which is typically when any entity opposed to the claim would register an objection. Nor is it clear why DeMarco would choose to wade into another politically heated battle over principal reduction, though his objections to debt relief more broadly center on what he sees as a risk of contagion, and lasting harm to the market that finances home loans.
In ruling out last week -- once and for all, it seems -- principal reduction on any Fannie or Freddie loan, DeMarco cited the risk of "moral hazard." His point, essentially, is that offering debt relief to a targeted group of borrowers -- the up to 500,000 that might qualify for debt relief under a Home Affordable Modification Program -- might encourage others to strategically default in order to obtain the same benefit, in the same way that feeding a neighbor's cat poses the risk that you will soon be setting up a kitty buffet for the whole neighborhood.
Moreover, writing down loan values would spook the mortgage markets and make it more difficult for borrowers to buy and refinance homes, he said. This fear outweighed new findings by his own agency that found that taxpayers would likely actually benefit from targeted principal reduction, to the tune of up to $1 billion.
Critics of this view say there is no evidence that struggling homeowners will intentionally stop paying, and thus risk their home and their credit, in order to potentially benefit from debt relief. DeMarco's shutting the door on principal reduction last week ratcheted up the calls from many in the housing community for him to step down, or for President Barack Obama to use a recess appointment to name a permanent director.
Public hearings on the use of eminent domain to seize mortgages are set for next week in Chicago and in San Bernardino County, in California.
Below are the people who love and hate Ed DeMarco:
Paul Krugman, Nobel Prize Winning Economist
Nobel Prize-winning economist and New York Times columnist has repeatedly called for FHFA director <a href="http://krugman.blogs.nytimes.com/2012/07/31/fire-ed-demarco/" target="_hplink">Ed DeMarco to be fired</a> over his his opposition to principal reduction. In addition to arguing that principal reductions would benefit the overall economy, Krugman told his readers that "deciding whether debt relief is a good policy for the nation as a whole is not DeMarco's job."
Timothy Geithner, U.S. Treasury Secretary
Treasury Secretary Timothy Geithner stated that principal reductions would help up to 500,000 homeowners and save taxpayers up to $1 billion, in <a href="http://www.huffingtonpost.com/2012/07/31/ed-demarco-principal-reduction_n_1724880.html" target="_hplink">a letter he wrote to Ed DeMarco. </a> He also wrote that DeMarco's resistance to principal reductions was not "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 the taxpayer."
Rep. Elijah Cummings (D-MD)
Rep. Elijah Cummings is less than thrilled by Ed DeMarco's decision not to provide principal reductions. Cummings wrote in <a href="http://www.huffingtonpost.com/2012/07/31/ed-demarco-principal-reduction_n_1724880.html" target="_hplink">an email</a>: <blockquote>"It is incomprehensible that Mr. DeMarco would reject the chance to save up to a billion dollars in taxpayer funds while helping nearly half a million homeowners stay in their homes," Cummings said. "He should immediately withdraw this reckless and misguided letter and start following the law Congress passed."</blockquote>
James Lockhart, Former Chairman Of The Federal Housing Finance Agency Chairman
President George W. Bush's Chairman of the Federal Housing Finance Agency, James Lockhart (seated to the far right), has argued that the FHA ought to experiment with principal reductions, <a href="http://thehill.com/blogs/on-the-money/1091-housing/225101-cummings-housing-regulator-fhfa-wasting-taxpayer-money-by-refusing-principal-forgiveness" target="_hplink">the Hill reports.</a> "Foreclosure is not the answer. ... We're destroying neighborhoods with foreclosures."
Sen. Richard Durbin (D-IL), Senator Majority Whip
Senate Majority Whip Richard Durbin (D-IL) told reporters that he believed DeMarco's decision was "short-sighted" and "an abdication of his responsibilities, " <a href="http://thehill.com/blogs/on-the-money/banking-financial-institutions/241343-fhfa-opts-against-principal-mortgage-reductions" target="_hplink">the Hill reports.</a> "The alternative to principal reduction is foreclosure -- a disastrous outcome for homeowners, taxpayers and the American economy. It is way past the time for leadership to stabilize our real estate market."
Shaun Donovan, Secretary of Housing and Urban Development
Secretary of Housing and Urban Development, Shaun Donovan, has urged the use of principal reductions to prevent foreclosure, <a href="http://thehill.com/blogs/on-the-money/1091-housing/225101-cummings-housing-regulator-fhfa-wasting-taxpayer-money-by-refusing-principal-forgiveness" target="_hplink">the Hill reports.</a>
William Dudley, President Of The New York Federal Reserve
William Dudley, president of the New York Federal Reserve, argued for the development of an earned principal reduction program for borrowers who are underwater but still making mortgage payments, <a href="http://www.newyorkfed.org/newsevents/speeches/2012/dud120106.html" target="_hplink">In a speech to the New Jersey Bankers Association. </a>
Christine Lagarde, International Monetary Fund Managing Director
International Monetary Fund managing director, Christine Lagarde, argued that the U.S. should implement some form of mortgage relief, including principal reduction, in <a href="http://www.huffingtonpost.com/anna-cuevas/imf-lends-support-to-loan_b_1447133.html" target="_hplink">a speech she delivered at the Brookings Institute earlier this year.</a>
The Obama administration has long supported principal reductions, arguing that such write-downs would reduce delinquencies, help 11 million underwater borrowers and help get the housing market back on track, <a href="http://www.reuters.com/article/2012/05/10/us-usa-housing-donovan-idUSBRE8491DW20120510" target="_hplink">Reuters reports.</a> Under DeMarco's directorship, the FHFA blocked the White House's idea for home-energy improvement when it told firms not to participate, <a href="http://www.washingtonpost.com/politics/edward-j-demarco/gIQAK9StKP_topic.html" target="_hplink"><em>the Washington Post</em> reports.</a> President Obama attempted to replace DeMarco with North Carolina banking commissioner Joseph Smith in 2010, only to be rebuffed by Senate Republicans who refused to confirm Smith, leaving DeMarco in place.
Rep. Darrell Issa, House Government Reform And Oversight Committee Chairman
House Government Reform and Oversight Committee Chairman, Rep. Darrell Issa (R-CA), wrote a letter to DeMarco urging the FHA director to "carefully evaluate relevant information prior to making a decision that could cost taxpayers billions if the government were to pay down the principal value of underwater mortgages for select homeowners," <a href="http://thehill.com/blogs/on-the-money/1091-housing/225383-house-republicans-urge-housing-regulator-to-remain-steadfast-on-principal-reductions" target="_hplink">The Hill reports.</a>
Rep. Spencer Bachus (R-AL), Chairman Of House Financial Services Committee
Chairman of the House Financial Service Committee, Rep. Spencer Bachus (R-AL), told reporters that Ed DeMarco stood up for "the best interests of the American people" by rejecting principal reduction, <a href="http://www.nytimes.com/2012/08/01/business/us-agency-bars-fannie-and-freddie-from-reducing-principal.html" target="_hplink"><em>The New York Times</em> reports.</a>
Sen. Bob Corker (R-TN)
Sen. Bob Corker (R-TN) <a href="http://www.corker.senate.gov/public/index.cfm?p=News&ContentRecord_id=f3d4c62d-0f70-42fc-b485-99d0bb6b05b4" target="_hplink">thanked Ed DeMarco</a> for "making his decision based on objective analysis and with the taxpayer in mind."
American Bankers Association
ABA executive vice president on mortgage policy, Bob Davis, announced the association's support for Ed DeMarco's rejection of principal reduction, <a href="http://thehill.com/blogs/on-the-money/banking-financial-institutions/241343-fhfa-opts-against-principal-mortgage-reductions" target="_hplink">the Hill reports.</a> "As FHFA's research illustrates, principal reductions do not measurably help troubled borrowers avoid foreclosure, yet increase the cost to taxpayers at a time when our nation's fiscal situation is already strained."
Edward DeMarco, Federal Housing Finance Agency Acting Director
Acting director of the Federal Housing Finance Agency, Ed DeMarco, announced to Congress that he would <a href="http://www.huffingtonpost.com/2012/07/31/ed-demarco-principal-reduction_n_1724880.html" target="_hplink">not permit mortgage giants Fannie and Freddie Mac to assist struggling homeowners by reducing their principal.</a> In a letter DeMarco sent to Congress, the acting director stated that he did not believe that there would be a substantial financial benefit to the taxpayer and that reducing principal would introduce "moral hazard" into the housing market. "This could give borrowers who are current on their mortgages a message that the government endorses forgiving a portion of mortgage debt if hardship can be demonstrated, creating a very broad incentive for underwater borrowers to seek ways to become eligible." Under DeMarco's directorship, the FHFA blocked the White House's idea for home-energy improvement when it told firms not to participate, <a href="http://www.washingtonpost.com/politics/edward-j-demarco/gIQAK9StKP_topic.html" target="_hplink"><em>The Washington Post</em> reports.</a> President Obama attempted to replace DeMarco with North Carolina banking commissioner Joseph Smith in 2010, only to be rebuffed by Senate Republicans who refused to confirm Smith, leaving DeMarco in place.<a href=" Under DeMarco's directorship, the FHFA blocked the White House's idea for home-energy improvement when it told firms not to participate, a href="http://www.washingtonpost.com/politics/edward-j-demarco/gIQAK9StKP_topic.html" target="_hplink"emThe Washington Post/em reports./a President Obama attempted to replace DeMarco with North Carolina banking commissioner Joseph Smith in 2010, only to be rebuffed by Senate Republicans who refused to confirm Smith, leaving DeMarco in place.a href="http://www.huffingtonpost.com/peter-s-goodman/ed-demarco-fannie-freddie-principal-reduction_b_1336190.html" target="_hplink"http://www.huffingtonpost.com/peter-s-goodman/ed-demarco-fannie-freddie-principal-reduction_b_1336190.html/a" target="_hplink"> leaving DeMarco in place.</a>