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Servicing

Here’s why the FHFA is not a fan of principal reduction

Who's going to pay for that?

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Yet another exasperated article, this time in The Washington Post, that seems to ask the untiring question of why the Federal Housing Finance Agency will not allow for widespread principal reductions at Fannie Mae and Freddie Mac.

And yet again, we have another downtrodden homeowner paraded out for emotional exploitation by pro-reduction policy wonks and "if it bleeds it leads" journalists. Where is the opinion of the mortgage servicer? Or the mortgage lender?

Dina ElBoghdady cites the housing tale of Jaime and Juana Coronel and their rough ride onboard America’s economy. Like many of us, they’re caught between a rock and a hard place.

And so the article goes, from one homeowner advocacy group to another, with a shot of Moody’s in between. At the core is the basic question: Why won’t FHFA director Mel Watt allow for principal reductions?

ElBoghday writes:

“One of the most effective ways to ward off foreclosure in such cases is for lenders to reduce the size of the loans. Policy makers and many of the nation’s largest banks reluctantly have come to embrace this type of debt relief — called principal reduction.”

“Buy-back arrangements like the one the Coronels requested amount to a principal reduction. The couple is asking Fannie to sell them the home at its current market value, which essentially would leave them with a smaller mortgage and lower monthly payments while positioning them to build equity if home values rise.”

Let’s set aside the contradiction of foreclosure trauma from just a breath before when ElBoghday writes: “the Coronels regained their financial footing.”

And let’s also set aside that Watt is far from silent on homeowner assistance. In fact, he's a man of action, just not the type of action some are after. Just last month, for example, he began a renewed push to get more borrowers in HARP.

“We know that there are hundreds of thousands of borrowers who can still benefit from HARP and are essentially leaving money on the table by not taking advantage of the program,” Watt said in a statement, not included in the WaPo piece.

Principal reductions come in the form of mortgage modification, of course, and not refinancing. So why has this tool, in particular, been disregarded by the two people who have so far led the FHFA?

Once principal reductions become available, even borrowers with financial footing, such as the Coronels, will be able to apply for the assistance.

And who pays the difference between money owed on the mortgage and writing down the house to market value? Who takes the hit in the Coronel case?

Fannie Mae, that's who. If they do enough of these write-downs and the taxpayer will be on the hook as well.

And what will the borrower with a newly minted principal reduction do with a fair value property? Build equity. Sell. Keep profit.

Luckily, it’s not likely to happen, according to Brent Nyitray, director of capital markets at iServe Residential Lending.

He wrote a blog this morning taking a much more analytical approach to the WaPo article than my blog on the subject.

Here’s what Nyitray said:

“Not sure [write-downs] is going to happen, as it would undoubtedly trigger a wave of strategic defaults. Interesting that the couple mentioned in the article said they refinanced into a loan with "abusive" terms. A Fannie Mae loan was abusive? Or was this part of the American Dream Commitment, where Fannie partnered with the big subprime players like Countrywide, Irwin, Doral, etc. and agreed to buy their loans for their own balance sheet. Anyway, it looks like Mel Watt is giving the affordable housing advocates the Heisman and running out the clock on principal mods, much to the chagrin of the left.”

For Mel Watt to commit Fannie and Freddie to principal writedown as a policy could lead to profit erosion at the government-sponsored enterprises — and potentially down the slippery slope to yet another bailout.

It's a bad idea and not likely to happen.

But at least it would give homeowner advocates and bleeding-heart reporters plenty more to complain about.

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