“We concluded that the potential benefit was too small and uncertain relative to the known and unknown costs and risks,” DeMarco told reporters after a months-long agency analysis.
DeMarco’s decision came despite prolonged pressure from the Obama administration, Democratic lawmakers on Capitol Hill and housing advocates, who argued that principal reduction is an essential tool in softening the fallout of the housing crash.
Treasury Secretary Timothy F. Geithner chastised DeMarco for his decision in a letter Tuesday, even as he acknowledged DeMarco’s right to forbid principal reduction in his role as independent regulator for Fannie and Freddie.
“Five years into the housing crisis, millions of homeowners are still struggling to stay in their homes and the legacy of the crisis continues to weigh on the market,” Geithner wrote. “You have the power to help more struggling homeowners and help heal the remaining damage from the housing crisis.”
Geithner noted that the FHFA’s own analysis showed that Fannie and Freddie potentially could save $3.7 billion by participating in the administration’s housing program — and taxpayers could save $1 billion. A Treasury analysis accompanying the letter said that up to a half-million homeowners could benefit from the program.
In explaining his decision, DeMarco released a 15-page paper outlining the internal analyses that agency officials used to try to determine the costs and benefits of allowing principal reduction at Fannie and Freddie, which have been under government conservatorship since 2008 and hold about half of the country’s loans.
DeMarco acknowledged that under some scenarios studied by the FHFA, a principal-reduction program could save taxpayers money while also helping certain homeowners. But he was quick to note that any such program would take time and money to implement and that the potential savings could be wiped out by lower-than-expected homeowner participation or by a small percentage of borrowers deciding to “strategically default” on their mortgages. “We certainly have seen commentators actually encouraging borrowers to consider this kind of activity,” he said.
DeMarco reiterated his concern about the potential long-term consequences of principal forgiveness, saying that rewriting valid contracts could spook investors, encourage bad behavior on the part of homeowners and increase mortgage costs in the future. “It’s an important thing for us, the policymakers, to weigh,” DeMarco said, even as he acknowledged that such effects are “not readily measurable.”
The fight over principal reduction has stirred passions since the earliest days of the financial crisis. Consumer advocates and some economists have argued that it is the only way to finally end the housing crisis and bolster economic growth — by freeing borrowers of excessive mortgage debt. But many conservatives have resisted the idea, arguing that it would represent an unfair bailout for undeserving homeowners.
About a quarter of the nation’s homeowners remain “underwater,” meaning they owe more on their mortgages than their homes are worth; that excess of mortgage debt stands at roughly $700 billion. Some of the nation’s largest banks have undertaken limited amounts of principal reduction, and a $25 billion settlement finalized this year over foreclosure abuses prodded them toward doing even more.
Early on, the Obama administration also was skeptical about principal reduction. It included a modest — and ultimately ineffective — principal-reduction measure in its first rescue in 2009.
“This is a conscious choice we made, not to start with the principal reduction,” Geithner told members of the Congressional Oversight Panel in late 2009. “And we made that choice, because we thought it would be dramatically more expensive for the American taxpayer, harder to justify, create much greater risk of unfairness, and our program was not designed to do that.”
As the housing market continued to struggle, the administration tweaked its programs to try to encourage more principal reductions. This year, it tripled the payments it offered to banks to cancel debts and allowed Fannie and Freddie to tap the programs.
Lawmakers were quick to respond to DeMarco’s decision Tuesday.
Sen. Bob Corker (R-Tenn.) applauded DeMarco for basing his decision “on objective analysis” and for refusing to “bend to the political pressures.” Rep. Spencer Bachus (R-Ala.) praised DeMarco for “standing up for the best interests of the American people.”
Meanwhile, Rep. Elijah E. Cummings (D-Md.), an outspoken proponent of principal reduction, called Tuesday’s decision “incomprehensible.” Rep. Gary Peters (D-Mich.) accused the FHFA of “turning its back on hundreds of thousands of underwater homeowners.”
The decision renewed calls from DeMarco’s critics for President Obama to nominate a new FHFA director to replace him. The president tried that unsuccessfully in 2010, nominating former North Carolina banking commissioner Joseph Smith to the post. Smith withdrew his nomination when it became clear the Senate would not confirm him.
DeMarco on Tuesday seemed unrattled by the criticism and confident in his decision to defy those pushing for principal reductions at Fannie and Freddie.
“We’ve spent six months doing this analytical work, studying this issue, looking at the other programs that are available,” DeMarco said. “We had to make a decision. We made a decision. Others will now look at this and draw their own judgments.”