FHFA, DeMarco, and the Politics of Mortgage Modifications

Mortgage principal write downs are not a Republican v. Democrat issue. At least they should not be. But just as global warming apologists and deniers split down party lines without much to connect the deep roots of conservative ideology or progressive tradition, so too have mortgage modifications become a partisan issue.

In this context, the recent comments from FHFA Acting-Director Ed DeMarco are interesting for the responses that he has gotten. He has not, despite his favorable tone given to modifications last week that has not been heard in years, changed is tune. Nor has he given blank approval to modifications. Rather, he has always relied on FHFA analysis to determine what would involve the lowest possible losses for the taxpayers and has until now come up with a “no modification” strategy. Now the analysis is providing some room for modifications.

In the wake of the FHFA report, there has been a host of comments from both sides making political hay out of DeMarco’s words. Few have argued that FHFA’s analysis suggests reducing taxpayer losses at the GSEs by accessing a taxpayer funded incentive program called HAMP, in effect making a gimmicky accounting transfer (that is admitted in the FHFA report as a trade-off). Rather, the comments have been black and white views on principal write down as some kind of poison or healing potion, depending on the view.

So lets clear a few things up: How do mortgage modifications, principal write-downs or refinances, fit into the democratic platform any different from a republican platform? Does one party prefer the housing market to suffer while the other not? No. Nothing inherent about modifications makes this a partisan issue.

To hear the democrats tell it, the republicans do want the housing market to suffer more for wanting to see housing prices bottom out. Ironically, while it would be a good thing for housing prices to bottom out, most republicans (at least in Congress) have shied away from the legislative options put in front of them that would actually have the housing market bottom (lowering the conforming loan limit, unwinding the GSEs, etc). And there have been few voices on the Hill crying out about the injustice of the mortgage settlement—at least in regards to the way it treats contracts and pension funds.

To the the republicans tell it, the democrats want to just give free handouts to deadbeat borrowers who took on more than they can pay back. Ironically, while it is true that a wide spread principal write down program divorced from case-by-case economic consideration would involve free handouts to deadbeats, the GOP stands in favor of the mortgage interest deduction which gives free handouts to successful homeowners—and the point of the critic is the handout, not the deadbeat or the actual homeowner. More over principal write downs are not always bailouts.

The reality is that writing down the principal on a mortgage, which the investor or owner of the loan chooses to do so, can be the best way of recouping lent funds. Sometimes the losses will be higher without the write down. Sometimes the best guess at maximizing return is principal forbearance, rather than a straight up write off of the debt. And sometimes foreclosing on a home, fixing it up, and selling it, will yield the highest return.

Every case is different. Mortgages are individual products that, even if offered with the same dollar amount on the same terms, have different risk profiles based on the borrower (which has a wide number of variables) and the geographical location of the mortgage.

Even trying to estimate a mortgage’s risk profile based on zip code can be inaccurate because the possibility of vastly different neighborhoods and development prospects with a sometimes wide geographical zone defined by zip code. (If investors had access to address level data due diligence would be much more reliable.)

So it is ridiculous to reject principal write downs universally—as the GOP has done. And it is ridiculous to accept them blindly—as the democrats have done.

What we have written time and again is that the evidence suggests that principal write downs are often times not the best way of getting money back for lenders. That means forced principal write down programs are a bad idea—no reason to force banks to take losses. It means that the GSEs should not start writing down mortgage principal in large chunks—no reason the taxpayers hould have to cover those losses too.

But all of that is in the abstract. I don’t manage the GSE mortgage portfolio or the Wells Fargo portfolio of loans. Only those running the numbers can estimate on what the best option should be. I can point to the fact that more than half of the modifications under HAMP have failed. And we have done so in trying to push back on the idea that modifications are some how the panacea needed in the housing market.

They are not. But they might be answer to some mortgages.

Enter Ed DeMarco last Tuesday, who noted that in “some circumstances” lowering the mortgage debt level of borrowers could reduce the possibility of default. Such a conclusion is not earth shattering. While a majority of the HAMP modified mortgages have failed, some have succeeded and theoretically staved off foreclosure. What has been missed in many stories about DeMarco’s speech is that he was clear to point out that principal write downs are not a “magic bullet,” and the benefits are “limited.”

He is right to say these things and the GOP is wrong to suggest that there should be no modifications (though modifying the principal on a mortgage the GSEs do not own would be a problem without authorization from the investor). Democrats are equally wrong to claim some sort of victory as if the debate over whether or not to go all in on principal write downs is won. This is ultimately a debate about servicing debt and managing the deleveraging process. It is a debate about what tools to use in preventing more taxpayer losses. DeMarco framed it this way:

“This is not about some huge difference-making program that will rescue the housing market. It is a debate about which tools, at the margin, better balance two goals: maximizing assistance to several hundred thousand homeowners while minimizing further cost to all other homeowners and taxpayers.”

I will offer this critique of FHFA’s analysis though. FHFA suggests it can reduce losses to the taxpayers by $1.7 billion by taking advantage of incentive payments made by HAMP to those who write down mortgage principal. The challenge is that in order to do this, the taxpayers have to pay out those HAMP fees. So in this particular case, the FHFA “savings” to the taxpayers is little less than an accounting gimmick. It is possible that principal write downs would save taxpayers from higher losses, but if it is only because the losses are otherwise subsidized by the taxpayers then there is no net gain and moral hazard from the write downs wins the day.