Moral Hazard Worries Delay Mortgage Write-Down Decision

Published May 15, 2012

Probably few mortgage borrowers know who Ed DeMarco is, yet millions of them collectively could save more than $700 billion if he decides to allow Fannie Mae and Freddie Mac to forgive some mortgage debt.

Doing so likely would add to taxpayer burdens. Fannie and Freddie already have received nearly $200 billion in taxpayer bailout money. And for the vast majority of mortgage borrowers who are living up to their promise to repay what they’ve borrowed, such a move could be seen as a slap in the face – and a reason to stop paying their mortgages.

DeMarco is director of the Federal Housing Finance Agency, which oversees Fannie and Freddie, government entities that have become the biggest players in the nation’s home mortgage market.

Heavy Pressure

He is coming under heavy pressure to allow Fannie and Freddie to write down mortgages in their multi-trillion dollar portfolios but so far has stood firm.

“The only thing standing in between the White House and a bailout of 11 million borrowers underwater on their mortgages to the tune of $717 billion is the FHFA’s Edward DeMarco, who has had the temerity of suggesting that the agency merely follow the law and protect taxpayers from unnecessary losses,” said Bill Wilson, president of Americans for Limited Government, which opposes a mortgage bailout.

DeMarco had promised a decision by May 1. But on May 1 the FHFA announced the decision was being delayed indefinitely.

“FHFA continues to work on its principal forgiveness analysis and is in discussions with the Department of the Treasury,” an FHFA spokeswoman said. “A final determination…is being deferred until we conclude these activities.”

Moral Hazard Fears

DeMarco has expressed worries that principal forgiveness could encourage more borrowers to stop paying their mortgages in hopes of having the amounts they owe reduced.

In a recent article in American Banker magazine, Alexander R. M. Boyle and Robert D. Broeksmit supported DeMarco’s position. Boyle is the retired vice chairman of Chevy Chase Bank and Broeksmit is a senior director at Treliant Risk Advisors and a former president of a unit of Chevy Chase Bank. They wrote:

“[L]et’s look at the case of two borrowers – one family who bought with zero down and their neighbors who put 30% down. Assume in this example that both loans were sold to or guaranteed by Fannie or Freddie. After a 30% value decline, Borrower A is now 30% upside down and Borrower B is at 100% loan-to-value. Should the taxpayer, which effectively owns both mortgages, pay to put borrower A on an equal footing with borrower B? Why wouldn’t every borrower in the community want an equivalent reduction in principal with that which was granted to borrower A?”

They added principal reduction would not apply “to borrowers who honor the terms of their note through timely payment. But what sort of perverse incentive is that? Wouldn’t it encourage all borrowers to stop their monthly payments so that they could qualify for principal reduction?”