Suppose you are going to repair your damaged home and your only tool on hand is a roll of duct tape. Your resourceful neighbor points out that you could probably also use a hammer, a drill, and a saw.
If you're the FHFA, you tell him, "I can do a better job with just my duct tape, so thanks but no thanks."
That, in a nutshell, is the problem with the most recent analysis by this key regulator of the mortgage giants Fannie Mae and Freddie Mac when it comes to adding the tool of principal reduction to their anti-foreclosure toolkit. They've made progress in their evaluation of the costs and benefits of loan forbearance and loan forgiveness, but, somewhat bewilderingly, they appear to be comparing the two as if they were mutually exclusive. An optimal program of course will employ both, as some homeowners will benefit more from one than the other, and vice versa.
Some loans will fare better (have a higher net present value, or NPV) for Fannie and Freddie under forbearance, others under principal reduction, and many will fare better if they don't get either type of loan modification -- some folks simply need to get out from under the weight of their unsustainable home loans. The problem is that FHFA director Ed DeMarco is resisting the realization that all three of these options maximizes the interests of the GSEs and thus the U.S. taxpayer.
A bit of background:
Fannie and Freddie a) are currently 80 percent owned by taxpayers and b) hold or insure millions of mortgages, many of which are underwater. The last time I visited this issue, I pointed out that FHFA's analysis of how much taxpayers would save under these two options was flawed in various ways.
They've now improved that analysis, as presented in a speech by Director DeMarco a few weeks ago, a talk tellingly sub-titled "Is Principal Reduction the Answer?" (vs. is it one of the answers?). And when they improved their methods, they found that PR produces slightly more savings than PF (principal forbearance).
But the difference is slight -- less than $2 billion on potential losses of over $60 billion. Moreover, DeMarco expressed serious concerns that were the FHFA to ramp up PRs, they'd be incentivizing a slew of "strategic defaults" -- people who are current on their mortgages would intentionally fall behind in order to qualify for reduced principal.
The FHFA hasn't yet said what they're going to do, but they've been seriously dragging their feet and I'm afraid that given the rather fundamental mistake they seem to be making they may get this wrong. Neither I nor anyone else, including the White House (which recently tripled the incentives for the FHFA to add the PR option), believe that this is the silver bullet. In fact, that's the point. There is no such bullet. But PR is the best way to keep some homeowners from losing their homes, and for these cases, it can help carve out of bottom on the still moribund housing market a lot faster than forbearance.
There are two remaining flaws in their calculus. First, DeMarco is almost surely over-stating the threat of strategic default. A homeowner who is current on their mortgage is just not likely to stop making payments, somehow slip to at least 15 percent underwater, reduce their income enough to get through the Home Affordable Modification Program (HAMP) hardship screen, and take a certain and large hit to their credit score, all on the outside chance that they are found eligible for HAMP, and, if eligible, qualify for principal reduction rather than some other, lesser form of modification (HAMP is the program through which these modifications are made available).
In other words, the bar for getting loan forgiveness through HAMP is set fairly high, expressly to avoid this moral hazard. DeMarco himself believes that only "several hundred thousand homeowners" are in this universe. (I think he's lowballing, but what matters here is what he thinks.) I doubt many people who are now current on their mortgages will play that lottery.
The second flaw is the "Keep your damn tools, I'll just use my duct tape" problem. From what I can tell, the FHFA analysts are comparing the NPV outcomes under forbearance to those under PR. Except for the folks with deep negative equity, that will almost always favor forbearance (and shield banks from principal writedowns). For homeowners with just a little negative equity -- the low loan-to-value (LTV) folks who are less likely to default-PR represents an expensive loss to banks and investors. But for those with high LTV ratios, who are much more likely to default, it's a much better deal for investors, GSEs, taxpayers, and of course, the homeowners themselves.
So the right way to determine who should get HAMP PR is to figure out under which scenario is the homeowner least likely to default. And the right way to do that is to evaluate the incremental value of providing PR to those who qualify for forbearance to see if adding the new option further increases the NPV of the modification.
In some cases, particularly folks who are less underwater, the additional step won't be necessary. But for those with high LTV's, the advantage of PR should show up pretty clearly.
I agree with DeMarco (from his Brookings speech):
"This is not about some huge difference-making program that will rescue the housing market. It is a debate about which tools, at the margin, better balance two goals: maximizing assistance to several hundred thousand homeowners while minimizing further cost to all other homeowners and taxpayers."
That's why it's so important that their FHFA's analysis makes use of all the tools. Don't get me wrong -- you can go a long way on duct tape alone. But whether you're trying to repair a home or a housing market, you need to use all the tools you can get.
This post originally appeared at Jared Bernstein's On The Economy blog.
Follow Jared Bernstein on Twitter: www.twitter.com/@econjared
Richard (RJ) Eskow: DeMarco Speaks! (With Closed Captioning for the Mortgage-Impaired)
The big question is: what is the optimal way to structure human society so that human beings are most efficiently able to live contented lives? I'm sure there's more schemes for organizing society than I can think of, but this video does a fairly good job of condensing the big ones down:
http://youtu.be/N4r0VUybeXY
It's a question of efficient system design - as well as a moral question about the rights of the individual. I personally don't think it makes sense to erect a government with the authority to manipulate real estate markets in order to achieve some goal. Or manipulate any markets really. Politics should not be the venue to plan or decide the industrial or economic future of the society.
Change in a free society should come from the voluntary interactions of free people and their choices. Government should focus on enforcement of justice - and leave the discovery of what the energy schemes, or medical care delivery services, or housing, or education of the future will be to the choices of the people.
If your still employed and making a above average wage , more power to you.
But not everyone who is struggling bit off more then they could chew . It seems more reality based that the over pricing of the property in the first place is what has led to this .
Via the realesate experts and huge profits for all envolved ......and for those who don't believe ......why can't all these deadbeats just sell their homes for the appraised value and just move on ?.......no harm no foul?
Why because the values were trumped up by the same people now wanting to forclose or not work with anybody.... because it's all money back in their pockets, no matter how much they screw up the country as a hole.
I believe another indirect benefit of principle reduction is that when it puts a homeowner above water, the homeowner can then sell the house. Homeowners under water are stuck. They cannot seek employment elsewhere - in another town, city, or anywhere where they would have to move. This situation surely must be hurting employment. The workforce is not as mobile as before the housing crash.
I realize that may not help NPV for F&F, but I believe it would help the economy overall, which in the end should help F&F.
In Mexico in the mid-'90s Wall Street engineered a currency coup that tripled the debt owed by small businesses and family farms and also allowed for them to be massively ratejacked on top of it. Mexicans consequently formed the "el Barzon" movement and pushed back Wall Street and deposed their ruling party of 60+ years. In this country YouTube phenom Ann Minch has already declared the debtors' revolt and begun going after them.
If you've been pushed under, you can read every other page of my book for free: http://www.scribd.com/doc/25443175/Debt-Hope-Down-and-Dirty-Survival-Strategies-Evaluation-Version-Complete
While all you say about principal reduction may be so, but I still have a fundamental problem with the whole idea. Why? Because we are going to go out of our way to "rescue" the most irresponsible of borrowers - those who have over-reached and failed.
People who have lived within their means and kept up their payments will continue to struggle while those who made poor choices will be rewarded for that behavior.
Related question for those of us who are far from tax experts - are their tax implications to principle reduction? Doesn't PR amount to a form of monetary benefit? And if so, is it taxable?
F&F, meaning we taxpayers, fund those squatters staying in houses they do not own. Total cost is $300B, about $1000 per-capita we'll pay for those deadbeats. Author is saying we should pay even more. They are living mortgage and rent-free while I'm paying rent. I should have taken out a subprime mortgage too, I could be living rent-free now too.
It's called "moral peril", if you reward bad behavior it encourages it. But the real moral peril here is simple: if people get away with not paying back loans, banks will never lend again. And guess what? They are not. Nobody is writing mortgages other than F&F. That will be shut down in a few years by Congress, then the private mortgage market in the US will be gone, forever.
And they are not homeowners. A mortgage is a lease, like an auto or apartment. You own the property when you pay in full, otherwise you are evicted if you stop paying, aka foreclosed.
The borrowers in default are not doing home repairs, they are letting the houses they do not own fall apart, so that when they are foreclosed it will cost F&F and we taxpayers even more. All the while not paying rent or mortgage, also funded by taxpayers. They are victims only of buying an overpriced house. The house seller got that big profit, the banks lost money on it.
I bought stock, then the price fell. Wall St sold me that stock, just like CDOs they were rated AAA by S&P. Why aren't I being reimbursed for the fall in stock prices, like they are for a fall in house prices? No difference, nobody guarantees assets will increase in price.
And remember, the economy was great in 2007 until housing prices started dropping and those with "no money down", home equity loans and second houses, pure speculators, "walked away" from their legal responsibility. THAT started the meltdown and caused the current high unemployment. Deadbeat borrowers caused this recession. If you consider that unemployment went from 5% to 10%, that means only 5% lost their jobs - but 13% of mortgages are in foreclosure!
In other words, the majority of those who are refusing to pay had no change in job status, the numbers don't add up. They are just trying to get out of a bad investment, had no intention of living there long-term. The majority are perps, not victims.
I too have been responsible. I bought a home with a fixed rate mortgage I can afford, and I've made every payment. Why should I be on the hook for people who over-reached, bought homes they could not afford, or did not understand what "adjustible rate" means?
Today, Inspector General for TARP Romero wrote the following to Congress:
After 3½ years, the(“TARP”) continues to be an active and significant part of the Government’s response to the financial crisis. It is a widely held misconception that TARP will make a profit. The most recent cost estimate for TARP is a loss of $60 billion. Taxpayers are still owed $118.5 billion (including $14 billion written off or otherwise lost).
Earlier this month, Romero stated that the portion of the Tarp funds which were supposed to help homeowners haven’t been disbursed:
A fund to support homeowners in the communities hit hardest by the collapse of the housing bubble has disbursed just 3 percent of its budget and aided only 30,640 homeowners in the two years since its creation, according to a report released on Thursday by a federal watchdog office.
The "Hardest Hit Fund", was created in the spring of 2010, grants money to state housing finance agencies for efforts to help families that are facing foreclosure. It has “experienced significant delay” because of “a lack of comprehensive planning” by Treasury Department and limited participation by Fannie, Freddie and the large mortgage servicers, said the report by the inspector general for the TARP.
“Look at the TARP money that goes out to the banks,” Romero in an interview with Huffington Post “That goes out in a matter of days. This has been two years and only 3 percent of these funds have trickled out to homeowners.”
those are the actual facts.
WHY SO LONG? Why no help? Because REAL value, and HUGE margins, will tell the tale of the untaxed profiteer c.o.living inflated, outsourced, cr@p job, economy numbers. Chinese interest, buying up our land can't bring home values up to all-out racketeered, Fed flooded ballooned, pricing.
What on earth will they use as added capital to drive oil if our mtg values are set down to real value? Outsourcing and oil futures will have to be double-down favored, to ensure property/earned equity handover.
Now this fellow asserts that we should offer principal reduction to "some" underwater borrowers but not others. Another poster hit the nail on the head. By what formula would one determine the amount of principal reduction?Where does it end and if only some qualify but not others it would seem to reward, and very arbtirarily at that, irresponsible borrowers.
Hey, I would love to be able to sell my home or at least make improvements to it. I am fully aware of the criminality of these thieves on Wall St. and am outraged at what they have done to this country's economy(not to mention my own economy) while they raided the henhouse. That said, you simply cannot arbitrarily just reward some with reductions while letting others languish all because they "don't qualify". All because we pay our bills, no matter how inconvenient.
- Karl Marx
And yet, for some reason it's beyond the pale to point out how modern American governance seems to trend towards communism.