Nov292011

House Democrats lobbied to give free money to loan owners in 2011

The legions of hopelessly underwater loan owners are all praying for a write down on their mortgage. It’s a false hope, but with falling prices and little prospect of a recovery any time soon, false hope is all many of these borrowers has left.4.2.7

US House Democrats press for mortgage write-downs

Reuters — WASHINGTON | Tue Nov 22, 2011 4:33pm EST

Nov 22 (Reuters) – More than 20 Democrats in the U.S. House of Representatives on Tuesday called on the regulator of Fannie Mae and Freddie Mac to help underwater borrowers by allowing their loan principal to be reduced.

The regulator has faced increasing pressure to permit the write-down of principal by the two government-controlled mortgage finance providers as a way to help some of the millions of Americans who owe more than their homes are worth. The Federal Housing Finance Agency, however, has stood fast out of concern such a change would undercut finances of Fannie and Freddie.

We strongly urge that you reconsider your refusal to allow principal reductions to achieve better-performing (loan) modifications and avoid the extreme losses of unnecessary foreclosures,” the 21 lawmakers wrote in a letter to the FHFA.

Nobody is discussing the bigger issue of moral hazard. If you give away free money, it will encourage imprudent borrowing because the borrowers know they can petition for a bailout and get it. That’s the real reason we shouldn’t consider principal reductions.

I am relieved the FHFA is resisting increasing the losses on the government’s GSE portfolio. Giving away free money will certainly do that.

As for the congressmen, their argument is specious. How does giving away free money avoid extreme losses? Doesn’t that guarantee losses? Are the congressmen really arguing that by giving away some now taxpayers will lose less later? Does anyone else see the insanity in that?

Fannie Mae and Freddie Mac provide guarantees to investors against the possible default of loans, which encourages banks to make new loans. The two companies are the biggest sources of U.S. mortgage financing, and regulations on their activities have a widespread effect on the mortgage market.

Fannie Mae and Freddie Mac, which were taken over by the government in 2008, have together received more than $145 billion in taxpayer-funded support.

Given an expanding gap between U.S. home values and mortgage balances, many Democrats and housing industry representatives have argued for comprehensive anti-foreclosure efforts that include principal write-downs.

They are arguing against the cure to the problem. If they really wanted to bring down the gap between home values and mortgage balances, they would foreclose on underwater borrowers and put them out of their misery. These congressmen are correct that the gap between what the houses are worth and what is owed needs to be reduced, but their method of doing so is all wrong. Principal forgiveness will not deter irresponsible borrowing in the future. Foreclosure has consequences, principal forgiveness does not.

Mortgage modifications usually involve a reduction in the interest rate but not the principal balance of the loan.

In the letter, Democrats estimated principal reductions for troubled borrowers would lead to lower defaults and reduce the risk of default for about 20 percent of Fannie and Freddie’s portfolio.

So they want to give away the money because the GSE might lose it? How stupid is that?

Efforts to reduce principal debt are rare, often voluntary. Fannie and Freddie are also concerned that writing down loan balances would create a moral hazard — the concept that rescue efforts breed further behavior that exacerbates the existing problem — prompting other borrowers to stop making timely loan payments.

They shouldn’t just be concerned, they should be quite certain principal forgiveness will lead to moral hazard. No borrower will ever be prudent again. If borrowers believe they have no risk in the transaction, they will take all the money they can get under any terms available because they know they will get bailed out if things go wrong.

“The performance of the enterprises’ mortgage modifications leaves much to be desired for homeowners, for the housing market, and for taxpayers,” Representative Brad Miller, a Democrat and a member of the House Financial Services Committee, said in a statement. Miller, who has proposed legislation to reform housing finance, led the Democrats in writing the letter.

Some economists see principal reductions as central to cleaning up the housing mess and preventing foreclosures.

Some economists are really stupid.

Settlement talks between the government and some of the biggest mortgage servicers to clean up alleged foreclosure abuses include widespread principle reductions in their agreement.

There’s the money shot — the false hope to keep more loan owners paying. Widespread principal reductions are coming, right?

If there is principal reduction in the agreement, it will be targeted to the most severely underwater borrowers who are most likely to strategically default anyway. By reducing the principal a little, they will get a few more payments out of the borrowers before they implode. Perhaps this is what the Democrats had in mind when the proposed principal reduction, but I rather doubt it.