A top housing regulator on Tuesday spurned a proposal from President Obama and congressional Democrats to let homeowners write down the principal on their mortgages.
Edward DeMarco, the acting director of the federal agency that oversees Fannie Mae and Freddie Mac, said the risk to taxpayers from the mortgage aid would far outweigh the benefits.
“We concluded the potential benefit was too small and uncertain relative to unknown costs and risks,” DeMarco, the head of the Federal Housing Finance Agency (FHFA), said in a letter to Congress.
DeMarco's move drew a swift rebuke from the Treasury Department, which had pushed FHFA to forgive some mortgage debts in a bid to boost the economy.
“I do not believe it is the best decision for the country,” Treasury Secretary Timothy Geithner wrote in a letter to DeMarco.
“The use of targeted principal reductions by the [government-sponsored enterprises] would provide much-needed help to a significant number of troubled homeowners.”
The housing market has struggled to recover from a severe downturn, and some housing experts have argued that lowering the principal for some homeowners, especially those who are underwater on their mortgages but current on their payments, would stem the tide of foreclosures.
But DeMarco, some lawmakers and banking industry groups remained skeptical and expressed concern that offering the reductions would start a slew of intentional defaults by homeowners who want to have their mortgage debts forgiven.
Congressional Democrats and the Obama administration argued that the policy would save taxpayers billions by reducing foreclosures on loans backed by Fannie and Freddie, which have needed nearly $190 billion in federal aid to stay afloat.
Geithner on Tuesday said allowing for the reductions would help at least 500,000 homeowners and save Fannie and Freddie upward of $3.6 billion over other types of loan modifications.
Democrats had pressured DeMarco for months to approve a principal-reduction plan and expressed exasperation with FHFA’s decision.
“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,” Elijah Cummings (Md.), the top Democrat on the House Oversight and Government Reform Committee, said in a statement Tuesday.
Cummings and fellow Oversight member John Tierney (D-Mass.) have accused DeMarco of withholding documents that would reveal the benefits of principal reductions.
Senate Majority Whip Dick Durbin (D-Ill.) blasted DeMarco's decision as "short-sighted" and an “abdication of his responsibility.”
“The alternative to principal reduction is foreclosure — a disastrous outcome for homeowners, taxpayers and the American economy. It is way past the time for leadership to stabilize our real estate market,” Durbin said.
DeMarco has argued that reducing interest rates, extending the duration of loans and offering principal forbearance arrangements to struggling homeowners provides a better balance than forgiving debts.
Anthony Sanders, a real estate professor at George Mason University who has been a vocal critic of principal reductions, said proponents of the write-downs choose to "ignore the moral-hazard aspect that greatly worried Mr. DeMarco."
Sanders argued that the plan would lead to more defaults, although a majority of homeowners with government-backed mortgages are current on their payments.
FHFA's examination found such a policy would encourage underwater borrowers who are paying on time to stop making payments.
"Imagine how many households would suddenly stop paying their mortgages," Sanders said.
“DeMarco is partly motivated by the concern that announcing a national reduction policy will stimulate a wave of mortgage defaults. I agree.”
House Financial Services Committee Chairman Spencer Bachus (R-Ala.) said DeMarco made the right call.
“The administration put incredible political pressure on Director DeMarco, and he deserves praise for standing up for the best interests of the American people," Bachus said.
“The administration’s foreclosure-mitigation plans have not and do not work.”
Tennessee Republican Sen. Bob Corker, a member of the Banking, Housing and Urban Affairs Committee, thanked DeMarco for “making his decision based on objective analysis and with the taxpayer in mind.”
The American Bankers Association, another critic of loan forgiveness, said there are more cost-effective ways to help struggling homeowners.
“Assisting troubled borrowers and encouraging recovery in the housing market is extremely important, yet there are more cost-effective and efficient options that carry fewer unintended consequences than principal reductions," said Bob Davis, the association’s executive vice president of mortgage policy.
“As FHFA’s research illustrates, principal reductions do not measurably help troubled borrowers avoid foreclosure, yet increase the cost to taxpayers at a time when our nation’s fiscal situation is already strained."