Nov252014

Mel Watt is doing a surprisingly good job

Mel Watt receives criticism from both political parties, demonstrating he balances the competing ends, a competent replacement for Ed DeMarco.

Melvin WattI was wrong about Mel Watt. Despite my concerns he would use his position to advance a left-wing agenda, at least so far, he’s proven a capable administrator of the GSEs. I am a big fan of Ed DeMarco, the man Mel Watt replaced, and perhaps I was not open to change at the GSEs because of my admiration for Mr. DeMarco, but so far Mel Watt has surprised me.

Prior to taking over as head of the Federal Home Finance Agency (FHFA), the overseer of the GSEs, Mel Watt pandered to left-wing constituents, promoting principal reductions and other destructive policies. It was reasonable to assume he would institute those policies as head of the GSEs, but like many others, I underestimated what a skilled liar he is.

It’s impossible to predict what Mel Watt will do because his words have no relation to his actions. He will say whatever he needs to to gain and remain in power, but he will do whatever he believes he should do to fulfill the requirements of his job. It may not be an admirable way to behave, but it’s a very effective behavior for a politician.

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So far he’s made good decisions at the GSEs. First, Mel Watt is not forgiving principal on underwater loans, despite pressure from the political left. He pandered to the left by loosening underwriting standards, but his announcement of 3% down loans is more public relations than substantive action.

In my opinion, the fact that Mel Watt gets criticized by both sides of the political spectrum shows that he is taking a balanced approach to managing the GSEs.

Sen. Warren accuses FHFA’s Watt: “You haven’t helped a single family”

Senator charges FHFA with dereliction on principal reduction4.2.7

“Five million families lost their homes during the financial crisis and millions more are still struggling,” Warren said, prefacing her questions to Watt. “According to the latest data from CoreLogic…another 5.3 million homeowners remain underwater on their homes. And people are continuing to lose their homes every day in foreclosure.

“We talk a little bit about the law here, now one of your duties under the law. One of your duties is to conserve the assets of Fannie and Freddie, but another duty given equal importance by Congress … is to implement a plan that seeks to maximize assistance for homeowners and take advantage of available programs to minimize foreclosures,” Warren said.

She went on to recite that Congress explicitly included reduction of loan principal as an option for the FHFA to use.

“Principal reduction is often a win-win that both helps Fannie and Freddie and helps a family,” she said.

When I first read this exchange, I was greatly impressed with Elizabeth Warren. She forcefully cuts through the non-stop Washington bullshit and asks pointed questions: I admire that.

However, I completely and totally disagree with the causes she champions — Principal reduction is the worst policy option. Principal reduction would create moral hazard on steroids. Borrowers already are prone to be irresponsible with debt, if they knew they couldn’t lose their homes and they might receive principal forgiveness if things go wrong, there is no incentive at all to be the slightest bit prudent. Worse yet, the American taxpayer is the one being asked to pay the bills. Why not just announce a government grant program to anyone who wants a house? That’s what they are really doing.

She cited a 2013 Congressional Budget Office study found that even a modest principal reduction plan for Fannie and Freddie mortgages could help 1.2 million underwater homeowners, prevent 43,000 defaults and save Fannie and Freddie about $2.8 billion.

Wrong! (See: Principal reductions fail to reduce future default rates)principal_forgiveness

“The Treasury Department has found that principal reductions could save Fannie and Freddie nearly $4 billion and help half a million homeowners stay in their home,” Warren said. “It has been six years since Congress created FHFA and in all that time your agency has never, not once permitted a family to reduce its principal mortgage through Fannie or Freddie.”

The Treasury Department study was bogus. Principal reduction wasn’t warranted once prices started rising because strategic default stopped and loan modifications became more widespread and accepted by underwater borrowers who had renewed hope. Principal reduction makes no sense at all today.

A clearly frustrated Warren continued.

“I’ve asked about this repeatedly and you’ve said you’d look into allowing Fannie and Freddie to engage in principal reduction; you said it again today,” Warren said. “You’ve been in office for nearly a year now and you haven’t helped a single family, not even one, by agreeing to a principal reduction. So I want to know why this hasn’t been a priority for you. The data are there.”

167995992MW004_PRESIDENT_OBMel Watt is a pandering liar. What did she expect?

Elizabeth Warren is upset about Me Wall not reducing principal, and I am relieved he hasn’t.

Watt appeared a little shaken by the line of attack.

“It’s probably an overstatement to say it’s not been a priority,” Watt stammered. “It’s just a very difficult issue. The reason it is difficult is because we are looking for exactly what you said – a win-win situation. We have to do this in a way that is responsible, otherwise we just reduce principal for everybody across the board…is not what anybody I think is advocating for, so then we have to decide what is a responsible way to do that—”

principal_forgivenessThere is no win-win situation here, which is why it hasn’t happened. There is only a transfer of wealth away from lenders and investors to homeowners. In fact, the main reason principal reduction hasn’t happened is because it would greatly impact pension funds that heavily invested in the bonds backed by underwater mortgages.

Warren cut him off.

“Chairman Watt, you have had a year to do that, you have known for five years before that what the problem was, we have two studies coming out showing that Fannie and Freddie could make money by doing this,” she said.

I’ll say it again, I admire how forcefully she calls bullshit when it’s warranted.

“In the meantime you have done the reps and warranties, the buyback policy, private mortgage insurance rules, a whole list of tough technical things, and I applaud you for doing that,

And so do I. He’s been surprisingly good at running the agency.mel-watt-principal-reduction

but people have lost their homes in the last year and every day that you delay more families lose their homes. There are 5.4 million families out there underwater so I want to know when are you going to have an answer on this?”

His answer is no, but he lacks to courage to say so.

Watt stammered in response.

“We are going to have an answer sooner – it won’t be as long as it has been…” he said.

Warren interjected, “How many more people have to lose their homes before we get there?”

She means to say, “How many more people have to lose their debts before we get there?”want_principal_reduction

Watt said that he couldn’t or wouldn’t take responsibility for what happened in the five years before he assumed the director’s chair at FHFA.

“But you’ve been there a year,” Warren interrupted.

“It’s not a year yet. And we are doing some things that really, may not call themselves principal reduction. But we are giving a lot more flexibility through the Neighborhood Stabilization Act,” Watt tried to say.

Warren seemed exasperated.

“But they are not principal reduction, let’s just be serious about this,” she said.

Watt wouldn’t cede ground.

But they are principal reduction if we facilitate the transfer of loans to other entities that do principal reduction and allow them to do principal reduction, that is principal reduction,” Watts said. “It is not across the board principal reduction…”

Earlier this year, I reported that mortgage delinquencies were much higher than reported because HUD and the GSEs were selling off their non-performing loans to others, but few believed me.

This statement by Watt is a rare gaffe — the truth. The GSEs sell off these loans so someone else is the foreclosing entity. On rare occasions the buyer may forgive principal, but most often, they foreclose and either rent or sell the property.American-Gothic-House-Underwater

Warren again interjected.

“Indeed, how many families has it affected?” she demanded.

“It has affected a number of—”

Warren cut him off.

“We have 5.4 million families outstanding with underwater loans and we‘ve got two principle studies showing what would happen if Fannie and Freddie would engage in principal reduction,” she said.

(See: Foreclosure Is a Superior Form of Principal Reduction)

Before her time expired, Warren also attacked Watt for pursuing borrowers for deficiency judgments.

The GSEs should attempt to collect from some of these borrowers. (See: As personal finances improve, debt collectors come calling)

Why principal reduction, and why not?

If every borrower in the country had their principal balance reduced to the lower of (1) current property values or (2) their ability to repay, prices would stabilize in most markets because the distressed property issues would be eliminated. With the distressed properties eliminated, prices would begin to rise, and HELOC spending could resume again. This would be a huge boom to the economy, and we could begin inflating the next Ponzi scheme. I could see government officials thinking this is a good idea.pay_our_debts

Principal reductions are the worst possible solution to the problem of excess debt left over from the Great Housing Bubble. Principal reductions merely gives foolish borrowers a pass. If the borrowers go through foreclosure, they have consequences that minimize moral hazard:

  1. Borrowers will be forced to rent, at least for a time.
  2. Borrowers will have reduced access to consumer credit as the foreclosure lowers their FICO score.
  3. Borrowers will have to save and be prudent in order to meet the standards of home ownership and get another loan.

All of those consequences — inadequate though they may be — are eliminated if the GSEs merely reduce principal. The borrowers who have the most to gain are those who borrowed most foolishly, and the people paying the price are (1) prudent borrowers and (2) those who didn’t borrow at all. Next time around, there will be no prudent borrowers, and everyone will participate. Who is going to pass on free money?

This is not an abstract concept or a phantom projection of the future. People respond to the incentives in their environment, and principal reduction creates the worst incentives imaginable.

the-moral-hazard-dilemma1

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