Would Mortgage Write-downs Spur More ‘Strategic Defaults’?

The regulator over Fannie Mae and Freddie Mac will decide this month if the two taxpayer-subsidized mortgage financing companies will embrace mortgage write-downs as part of the Obama’s Administration’s primary foreclosure prevention program.
In doing so, the regulator – Edward DeMarco, acting director of the Federal Housing Finance Agency – is wrestling with “moral hazard” as applied to the U.S. foreclosure crisis.
For DeMarco, moral hazard has to do with the risk of increased strategic defaults – cases were “underwater” homeowners walk away from their mortgage obligation knowing they would have a safety net available, possibly in the form of some mortgage forgiveness.
Fannie Mae and Freddie Mac own or guarantee 60 percent of U.S. mortgages outstanding, but they account for only 29 percent of seriously delinquent loans, a much lower proportion than their share of the market.
DeMarco’s mission as conservator of Fannie and Freddie is to minimize the impact on taxpayers, who have funded the two companies for more than $170 billion through quarterly bailouts since September 2008.
President Obama recently increased incentives for lenders to reduce mortgage principals under the Home Affordable Modification Program (HAMP), which currently has nearly 800,000 borrowers under active reduced-payment plans.
In addition to the 1.1 million loan modifications done by Fannie Mae and Freddie Mac, the two companies have done more than 1 million foreclosure prevention transactions with troubled borrowers – but no mortgage write-downs.
DeMarco, who has steadfastly resisted mortgage balance reductions, gave further insight into his mindset in a speech in Boston last week.
He emphasized mortgage forbearance as the tool of choice for helping “underwater” borrowers who owe more on their homes than their value. Forbearing involves charging a zero rate of interest on the forbearance amount and deferring its repayment.
“This (forbearance) approach recognizes that three out of every four deeply underwater borrowers in Fannie Mae’s and Freddie Mac’s book of business today are current on their loans,” DeMarco said. “These borrowers are demonstrating a continued willingness to meet their mortgage obligations. This should be recognized and encouraged, not dampened with incentives for people to not continue paying.”
In a weekend interview, the U.S. housing chief answered questions on DeMarco’s position and moral hazard. Shaun Donovan, Secretary of Housing and Urban Development, said during a C-SPAN interview that the risk group of those who would default because of a greater availability of write-downs represents a “small percentage” of underwater borrowers.
“The vast majority of homeowners don’t operate that way,” Donovan said. “The home is much more than an investment. The vast majority of folks are not going to put all of that at risk by (strategically) defaulting on their homes.”
Donovan added that Fannie and Freddie “shouldn’t’ punish the vast majority of folks where strategic default isn’t really a risk” because of a small number of borrowers who might walk away from their mortgages.

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