Obama Wants Help for Borrowers Who Are Still Making Payments

Published January 24, 2011

President Obama is proposing to use Fannie Mae and Freddie Mac to help homeowners who are still paying their mortgages but owe more than the houses are worth, but the proposal has strong opposition, including Rep. Randy Neugebauer (R-TX), House Financial Services Subcommittee chairman.

Neugebauer has sent a letter to Edward DeMarco, acting director of the Federal Housing Finance Agency, expressing “serious concern regarding recent reports that the Obama Administration is pressuring Fannie Mae and Freddie Mac to begin writing down mortgage principal in order to qualify underwater borrowers for lower-rate Federal Housing Administration (FHA) mortgages.”

Fannie Mae and Freddie Mac are “government-sponsored entities” (GSEs) that have trillions of dollars’ worth of mortgages in their portfolios. They back about half of all U.S. home loans. Many economists and real estate analysts say Fannie and Freddie played major roles in helping to create a housing bubble that burst, sparking the financial crisis of 2008.

Help For People Making Payments
Neugebauer is especially upset that the proposal would apply to borrowers who have continued to make payments on their mortgages.

Under the plan, Fannie and Freddie would identify borrowers who are current on their loan payments but who owe more than the houses are worth. Fannie and Freddie would hand those loans to the FHA, which would refinance them in return for a write-off of at least 10 percent of the unpaid principal balance. The Obama administration has not presented estimates of how much this program could cost.

“Since the program targets performing loans, it raises the question why it would be in the best interest of the U.S. taxpayer for Fannie and Freddie to write down principal on these types of loans,” Neugebauer wrote. “Before a decision is made by Fannie and Freddie to participate in any loan modification program that involves principal write-downs, we request a full report detailing the costs associated with participating in such a program.”

‘Taking from One, Giving to Another’
The proposal amounts to the federal government “taking money from one amorphous group, taxpayers, to give to another amorphous group, underwater homeowners,” said economics professor Arnold Kling of the Mercatus Center at George Mason University. Kling formerly worked as an economist for the Board of Governors of the Federal Reserve and as a senior economist at Freddie Mac.

“Just as it obviously transfers wealth to some homeowners, it obviously transfers wealth away from taxpayers,” Kling said. “The only exception would be that in a case where the transfer is just enough to keep the homeowners paying the mortgage. But that exception probably is not relevant. If Freddie or Fannie is trying to maximize profits, and one of these borrowers gets in trouble, then Freddie, say, will look at the case and decide whether or not a workout will prevent a default. If it judges a workout to be in its interest, it will do the workout.

“What this proposal amounts to is forcing them to do workouts, even in cases where, a, the borrower was going to pay anyway, and, b, where the borrower is going to default even with the workout,” Kling said.

Economist Mark Thornton said the proposed policy could cause additional problems in the system.

Losses Are Losses
“Forgiveness and forbearance will do little to help the massive number of homeowners who owe more than their houses are worth. Bad investments are bad investments,” said Thornton, an editor for the Quarterly Journal of Austrian Economics who began writing of a housing bubble in 2004, four years before the housing collapse.

“It’s just a matter of whether it is the homeowner or the bank that will take the losses,” Thornton said. “Just the idea of having such a program on the books creates a moral hazard so that future investors will depend on more bailouts.”

The Federal Reserve has already spent more than $1 trillion to buy mortgage debt since 2008, and there has been a huge expansion of Federal Housing Administration-backed loans.

FHA backing of loans started in the 1930s and historically has been used to help lower-income buyers borrow money to buy houses. FHA loans typically have gone to persons buying modest houses with small down payments, but they now make up more than 50 percent of all housing loans in many real estate markets.

‘Prudent to Walk Away’
Doug French, president of the Mises Institute in Auburn, Alabama, said, “As it is now, the propped-up Fannie and Freddie have no incentive to bargain with homeowners, and if the borrowers are current, Fannie and Freddie and the big mortgage-holding banks like Bank of America tell people, ‘Listen, we’ll talk to you if you get behind on your mortgage but not before.’ 

“For now, changes in the accounting rules allow banks to carry this paper on a mark-to-model basis no matter whether the loans are underwater or performing or not. Again, these rules serve to keep the banks from negotiating with underwater borrowers. So each individual underwater homeowner must make their own decision, but I don’t believe they are ethically challenged if they make the prudent financial decision to walk away, even if they can make the payments.”

Steve Stanek ([email protected]) is a research fellow at The Heartland Institute and managing editor of Finance, Insurance & Real Estate News.