Fannie Mae, Freddie Mac won’t be allowed to reduce loan balances for troubled borrowers

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.

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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.”