Investors may see prices ease on Fannie Mae and Freddie Mac mortgage bonds now that the Federal Housing Finance Agency rejected principal reduction on the underlying loans, according to market analysts.
Reaction to FHFA Acting Director Edward DeMarco's decision Tuesday cut predictably among homeowner advocates, politicians and economists.
Mortgage-backed securities analysts pointed out the FHFA statement cleared up the issue, and will likely relieve investors from paying a premium on the uncertainty of future principal reduction.
"This should be the final story on principal forgiveness at the GSEs," said Ed Mills, research analyst at FBR Capital Markets.
Mills did warn calls for removing DeMarco would provide some risk given election-year volatility.
For the nearly 4 million Fannie and Freddie borrowers trapped in negative equity, the decision will keep them waiting for home values to improve. While prices are moving up, the recovery will be slow for possibly years to come.
FHFA analysis did show the GSEs would save about $3.6 billion if roughly 500,000 mortgages qualified using unspent money Congress allocated for the Home Affordable Modification Program.
"It is incomprehensible that Mr. DeMarco would reject the chance to save up to a billion dollars in taxpayer funds while helping nearly half a million homeowners stay in their homes," said Rep. Elijah Cummings, D-Md. "He should immediately withdraw this reckless and misguided letter and start following the law Congress passed."
Rep. Spencer Bachus, R-Ala., chairman of the House Financial Services Committee led an effort to end HAMP last year and to put the remaining money toward the national debt. He praised DeMarco Tuesday for standing up to political pressure from the Obama administration.
"The administration's foreclosure mitigation plans have not and do not work," Bachus said.
Neil Barofsky, former Special Inspector General for the Troubled Asset Relief Program, pointed out on Twitter that the Treasury Department had the ability to force banks to write-down principal under HAMP, but chose not to.
"They had 250 billion in TARP funds that could've gone to helping homeowners. They could've made principal reduction mandatory when NPV+. And more," Barofsky tweeted.
Mortgage Bankers Association CEO David Stevens said in a statement that the decision brings some much-need clarification and urged other regulators to move on other rules such as the Qualified Mortgage and risk retention.
"We agree that principal forbearance can help borrowers realize a payment reduction in a similar way as principal reduction," Stevens said. "It is critical to implement solutions that help the American homeowner without incurring the negative long-term impact of making credit less available and more expensive."
Sen. Jack Reed, D-R.I., who represents a state with the second highest unemployment rate in the country, pointed out FHFA allows some principal reduction in states where Hardest Hit Funds are used and banks are writing down more mortgages than ever before.
"This seems to be a case of what's good for the goose is not good for the gander," Reed said.
Still, DeMarco has pointed out that if Congress wants principal reduction on GSE loans, they need only to vote for it. A bill from Sen. Robert Menendez, D-N.J., would create a shared-appreciation pilot program for both the FHFA and Federal Housing Administration. Principal would be reduced and both the investor and the homeowner would share the equity once it returns.
"Making decisions based on ideology rather than fact could cost Fannie, Freddie and taxpayers billions of dollars," Menendez said in a statement.
Many renewed calls to oust DeMarco, including economist and New York Times columnist Paul Krugman for ignoring benefits of the HAMP proposal the FHFA itself found.
"This guy needs to go," Krugman wrote.
The main concern in the DeMarco letter, however, centered around strategic defaults. Between 3,000 and 19,000 borrowers who otherwise would have been able to make their payments needed to default in order to wipe out benefits from the proposed program, according to the FHFA.
"DeMarco is partly motivated by the concern that announcing a national reduction policy will stimulate a wave of mortgage defaults," said Anthony Sanders, an economist at George Mason University. "I agree."
And, this, according to Mills was what drove DeMarco all along. Combine the strategic fear with an uncertainty over how the program would perform, and the decision shouldn't be a surprise. DeMarco said in his letter that borrowers most likely to be targeted by the program have gone delinquent for more than a year already and pose a high risk of redefault even after principal is reduced.
"I don't think he gets replaced. I think he's doing a very tough job balancing a lot of things," Mills said. "From a philosophical basis, he had a hard time believing that something could be a net benefit to Fannie and Freddie but also not increase the amount of money taxpayers would have to fork over."