Financially strapped borrowers whose mortgages are backed by Fannie Mae and Freddie Mac will not be allowed principal reductions to help save their homes from foreclosure, a decision that will impact consumers as well as communities.
Federal Housing Finance Agency acting Director Edward DeMarco said Tuesday that forgiving a portion of the amount due on a mortgage, one component of the federal government's home mortgage modification program, "would not make a meaningful improvement in reducing foreclosures in a cost-effective way for taxpayers."
Since September 2008, Fannie and Freddie have been operating under the conservatorship of the housing finance agency.
Fannie Mae and Freddie Mac own or guarantee more than 50 percent of outstanding mortgages, a market valued at $10 trillion. During the first quarter, 3.7 percent of Fannie Mae's outstanding mortgages and 3.5 percent of Freddie Mac's were seriously delinquent, meaning payments were at least 90 days past due and foreclosure proceedings could be initiated.
In January, the Treasury Department tried to boost the use of principal forgiveness by announcing it would triple the incentive payments it gave mortgage investors that agreed to reduce outstanding loan balances as part of the government's Home Affordable Modification Program. The Treasury also offered to extend those incentive payments to Fannie and Freddie. For months, the housing finance agency had said it was considering it.
DeMarco said Tuesday that 74,000 to 248,000 Fannie and Freddie borrowers could be eligible for modifications that included principal forgiveness.
"However, nearly all of this benefit is simply a transfer from the taxpayers to the enterprises, which would add to the over $188 billion in taxpayer support the enterprises have already received," DeMarco wrote. "Under other reasonable assumptions, implementing (principal forgiveness) would actually increase taxpayer costs."
DeMarco also noted that if the two government-sponsored enterprises were to offer principal reductions, they would have to widely publicize it and publish rules for more than 1,000 mortgage servicers. That could entice underwater borrowers who are current on their mortgage to stop making their payments to become eligible, leading to further losses for the two agencies.
In Illinois, 357,000 homeowners with Fannie- or Freddie-backed mortgages are underwater, meaning they owe more on their loan than the home is worth, according to the agency. Only Florida, California and Michigan have more underwater borrowers with Fannie- and Freddie-backed loans.
The decision is likely to further delay a recovery of the Chicago area's housing market, said Tom Feltner, a vice president at Woodstock Institute, a Chicago-based nonprofit research and policy organization.
In the year's first quarter, almost 33 percent of Chicago-area homeowners with a mortgage were underwater, a percentage higher than the national average, according to housing data provider CoreLogic. The firm also found that as of May, 10.4 percent of mortgages in the Chicago area were at least 90 days past due.
The agency's decision "is extremely problematic for the Chicago housing market," Feltner said. "There's widespread recognition that principal reductions work. (The decision) delays a much-needed market correction, and it's requiring states and municipalities to take much more drastic measures. That's why we've seen so much interest in seizing mortgages by eminent domain."
Local officials in San Bernardino County, Calif., have begun looking into the possibility of forcibly buying the mortgages of distressed homeowners through the power of eminent domain and then working with the homeowners to avoid foreclosure. Chicago Ald. Ed Burke, 14th, has proposed Chicago consider a similar plan.
The housing finance agency's decision drew a rebuke from Treasury. In a letter to DeMarco, Secretary Timothy Geithner said the decision was not "the best decision for the country," and he urged DeMarco to reconsider.
"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."
According to Treasury, 75 percent of non-Fannie Mae and non-Freddie Mac mortgages that have been altered recently through the affordable modification program contained principal reductions.
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