TheMReport — News and strategies for the evolving mortgage marketplace.
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cover story 800-pound gorilla in the Capitol is the growing call among liberals and academic economists for principal reductions on underwater mortgages. With about 11 million borrowers underwater—that's more than a fifth of homeowners nationwide—many of these analysts argue the economy's recovery could have been stronger and swifter with some form of mortgage debt forgiveness. Sufi, the Chicago b-school professor, teamed with a Princeton economist recently to analyze spending behavior among borrowers whose homes lose equity in a recession. What they found was stunning: The deeper underwater a borrower was, the less she spent elsewhere in the economy—by a huge margin. Since consumer spending is the backbone of economic growth, the academics concluded, principal writedowns could have the effect of a big tax cut—a $70 billion tax cut, according to the Washington Post's "Wonkblog." "The new evidence on the importance of household debt has convinced me that we are likely going to need to help homeowners who are underwater," Christina Romer—a top economic adviser to Obama—said in October. "Many of these troubled loans will need to be renegotiated and the principal reduced if we are going to truly stabilize house prices and get a robust recovery going." The White House tested the writedown waters in early 2012, playing with the idea of limited forgiveness for responsible borrowers of GSE-backed loans. But that plan needed the approval of Fannie's and Freddie's conservator, Federal Finance Housing Authority director Edward DeMarco. He refused to entertain the idea, arguing that "the potential benefit was too small and uncertain relative to the known and unknown costs and risks." Needless to say, the White House was steamed. Treasury Secretary Tim Geithner chastised DeMarco, beseeching him in a blistering public letter to "help more struggling homeowners and help heal the remaining damage from the housing crisis." Since then, liberal activists have lobbied hard to replace DeMarco and proceed with principal reductions; just weeks before the election, the Financial Times reported that White House sources were already treating DeMarco as a lame duck. This poses a risk for everyone up and down the mortgage origination and servicing chain—possibly far greater than any risk posed by other federal actions. "We think there is kind of a broad recognition, whether it's Treasury, the Fed, whether it's the GSEs, whether it's TARP, of where we are in terms of refinance policy. And I think the bigger difference is related to, obviously, things like principal writedowns and so forth," says Kain. (For more details on the looming fates of the GSEs, see "The Crystal Ball," page TK.) Freakout factor: 9. With a new FHFA head, plus a head of steam in the White House, this stimulus just might get enacted— on GSE loans, at least. It may have a positive effect on consumers and spending, but it will be bitter medicine for the financial sector. Time frame: The wheels are turning as you read this. Call your accounting department! The Crystal Ball: What's Next for Fannie and Freddie? With the Obama administration's proposal for replacing the government-sponsored enterprises (GSEs) still in progress, the uncertain future of Fannie Mae and Freddie Mac continues to be a catalyst for instability in the mortgage marketplace. However, a look at the four most likely scenarios for repositioning the GSEs can help banks and lenders prepare for what's ahead. 1 Though the White House's plan for the GSEs is still largely under wraps, insiders expect for it to focus on the development of new public-private partnerships that pass more of the mortgage-default risk to the market, while still maintaining some government guarantees. However, the administration has yet to reveal when they'll officially roll out their proposal. 2 Congressional Republicans and Democrats will also likely advance their own plans to wind down the government-sponsored enterprises come January. What will they look like? As Rep. Scott Garrett (R-New Jersey) told Bloomberg in November, "Government is not better at handling the mortgage market than the private sector." 3 Look to the CFPB and Congress to finally describe what a "quality residential mortgage" is; if the definition is narrow, the GSEs will likely have to continue their dominant role in the mortgage market, since most other lenders will cease to assume the default risk that comes with lower-quality mortgages. 4 Bottom line, via MortgageLoan.com's Kirk Haverkamp: Federal guarantees, whether explicit or otherwise, are here to stay. "The one thing you can count on is that the new system will seek to ensure the continued availability of the 30-year fixedrate mortgage, the centerpiece of the American housing market for generations and a product that would have a hard time surviving in a strictly private market." The M Report | 25