Principal Reduction - Who's Willing to Take the Haircut?

Democrats on the House oversight committee have apparently been pushing to subpoena the Federal Housing Finance Agency ("FHFA") to obtain an analysis looking at what effects principal reductions would have on Fannie Mae and Freddie Mac. 

As HousingWire has reported, FHFA Acting Director Edward DeMarco has long defended the agency's policy of keeping Fannie and Freddie mortgage servicers from writing down principal.  "We have been through the analytics of the underwater borrowers at Fannie and Freddie, and looked at the foreclosure alternative programs that are available, and we have concluded that the use of principal reduction within the context of a loan modification is not going to be the least-cost approach for the taxpayer."  It turns out that Mr. DeMarco's agency has yet to produce an analysis, which was requested last year by Democrats.

Several Democrats have cited a recent White Paper from the Fed allegedly acknowledging the need for principal reduction to coerce borrowers into staying in their home and provide a boost to the overall economy.  However, Fed researchers "admitted the potential benefits would be hard to quantify." 

Given that Fannie Mae and Freddie Mac already owe the Treasury roughly $151 billion in bailouts, it should come as no surprise that many are rightfully concerned about principal reductions, even if the pain of such reductions would be spread across the American populace.  DeMarco believes instead, Congressional action is required to force him to write down principal on loans held by Fannie Mae and Freddie Mac.  Between the two government sponsored agencies, the total of underwater mortgages is currently about $303 Billion.  The estimated loss to both agencies for principal reductions would amount to $101.7 Billion.  The scope of such a principal write down would cause great havoc for Fannie Mae and Freddie Mac's accounting, which would require immediate accounting losses. 

Interesting though, in the third quarter of 2011, servicers cut principal on 10,722 modifications, roughly 7.8% of all workouts during the period, according to the Office of the Comptroller of the Currency.  That is not an insignificant number, given the general reluctance of any servicer to consider a principal reduction.  While this number is interesting, it does not say exactly who is doing the principal reductions.  Either way, Fannie Mae, Freddie Mac, and many, many banks continue to face the specter of continued downward pressure on home prices, which will create additional underwater owners, which creates greater incentive to walk away (especially in non-recourse states).  We are no where close to getting out of the thicket on this one.   

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