Widespread principal reductions could save taxpayers $2.8 billion

[Update 1: Clarifies CBO findings]

The Congressional Budget Office released the result of its investigation into the potential costs a widespread mortgage principal reduction program may have on taxpayers’ bottom line.

The CBO concludes that, in one scenario, such a program could actually save taxpayers up to $2.8 billion.

Back in November, Rep. Elijah E. Cummings, ranking member of the House Committee on Oversight and Government Reform, requested an investigation into reducing principal for underwater mortgages backed by Fannie Mae and Freddie Mac.

“Today’s report demonstrates that principal reduction programs are a win-win-win for our country — helping U.S. taxpayers, American homeowners and our nation’s economy all at the same time,” said Cummings in a press statement. 

“Rather than implement these programs years ago when their benefits were obvious, ideologues ignored this evidence and harmed our nation as a result,” he added. “I hope this report provides a new opportunity to anchor our nation’s housing policy in facts rather than partisan politics.”

After examining multiple scenarios, the CBO concluded that principal reduction programs could reduce defaults and contribute a slight boost overall economic growth.

The CBO examined scenarios to bring homeowners to 115%, 100% and 90% loan-to-value ratios, anticipating up to 95,000 homes could benefit from such a program.

Ed DeMarco, the current acting director of the Federal Housing Finance Agency, which oversees Fannie and Freddie, is opposed to principal reductions.

However, President Obama’s expected pick of Rep. Mel Watt, D-N.C., to replace DeMarco at the FHFA would put the regulator on course to rapid changes with a potential populist replacing a financial regulator.

One of the largest oppositions to principal reduction is the moral hazard over loan forgiveness. Critics worry taxpayers will pay to reduce loan balances for homeowners, who may sell their properties at a profit and keep the proceeds.

“The most effective approach would be to offer principal forgiveness only to borrowers who were delinquent at the time the program was announced, thereby excluding borrowers who become delinquent in order to receive principal forgiveness,” the report states.

“Another approach would be to forgive a portion of the borrower’s loan in exchange for granting the lender a claim on future equity or home appreciation — that approach is known as a ‘shared appreciation’ modification.”

In one example provided in the report, the lender could get the right to receive 25% of any future increase in the home’s value.

A breakdown of findings is available below.

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