Big Numbers Still Don’t Sway DeMarco Towards Principal Reduction

While arguments continue to be made that Fannie Mae and Freddie Mac should apply principal reduction to keep underwater borrowers from going into foreclosure, Edward DeMarco, ""FHFA"":http://www.fhfa.gov/ acting director, still has plenty of ammo to defend his highly criticized stance.

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During a speech at the Brookings Institution Tuesday, DeMarco, despite revealing figures that showed the GSEs could potentially save $1.7 billion through the application of principal reduction, still cited reasons to be wary of the proposed foreclosure prevention solution.

For one, the $1.7 billion savings is a big ""if"" since all 691,000 borrowers would have to participate. The 691,000 includes the underwater delinquent population of GSE mortgages, plus 5 percent of the current ones that could transition into delinquency. DeMarco also explained that if 90,000 borrowers decided to get a strategic modification, as in miss payments or claim a hardship to qualify, the $1.7 billion in benefits would be eliminated.

DeMarco also showed data on the performance of modified Fannie Mae loans, which indicated that the loan-to-value (LTV) ratio was not strongly related to whether or not a borrower was current. A chart in the written portion of his speech revealed that borrowers with LTV ratios ranging as high as 190 percent and as low as less than 80 percent all had a similar percentage of loans current, falling around 70 percent.

Instead, loan performance, DeMarco said, is a matter of the payment changes. A separate chart showed that 79 percent of HAMP loans with a payment decrease of 30 percent were current, as opposed to 60 percent of loans with a payment decrease between 0 and 10 percent.

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So, rather than focusing on the total value of the home versus what is owed, the two charts indicated it is about monthly reductions.

Even with this data on Fannie Mae loans, DeMarco also noted contradictory claims, stating that historical data has shown the probability of default does correlate with the borrower's current LTV ratio, and a higher ratio leads to a greater likelihood of default.

""So, in theory, by forgiving principal and reducing a borrower's current LTV ratio, the probability of default is reduced and losses are reduced,"" said DeMarco.

When comparing the default rate of borrowers receiving principal forgiveness versus those who receive principal forbearance, DeMarco also said borrowers receiving principal forgiveness default less often.

However, the debate is not just about the borrower; investors' losses are considered as well.

""[T]he present value of the cash flows to an investor is higher for forbearance modifications than for principal forgiveness, as the upside return of the forborne amount is preserved,"" said DeMarco.

DeMarco also said, ""FHFA would have to consider the operational costs of implementing the program, and borrower incentive effects given that three quarters of the Enterprises' deeply underwater borrowers are current.""

Even though the GSEs account for 60 percent of all loans serviced in the U.S., DeMarco refuted claims that his current decision is going to prevent economic recovery.

With an estimated 11 million underwater borrowers, and some 600,000 plus borrowers potentially eligible for a HAMP principal reduction, DeMarco concluded the recovery does not rest so strongly on his decision.

""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,"" said DeMarco.