GSE PRINCIPAL REDUCTIONS – A ROSE BY ANY OTHER NAME…

I was mystified when I read this morning about FHFA’s Ed DeMarco’s reason for not supporting Fannie Mae and Freddie Mac doing principal reductions.  In his view, it would be just another big bank bailout.   Here’s his quote: 

"If you do principal forgiveness, who is it benefiting? ... Doing principal forgiveness is what would protect the big banks,"

His reasoning is based on the premise that the banks would be forced to write off second mortgages they hold which are subordinate to first mortgages guaranteed by the GSEs (as they would be wiped out by a principal reduction).

Yet he is in favor of rate/term loan modifications and points to the success of the agencies efforts in this regard since the inception of TARP.

Ironically, the same reasons to support to loan modifications apply to  principal reductions as well.  Specifically, if you also reduce principal as a part of a loan modification, not only you do increase a homeowner's ability to repay their loans, but you are also increasing their ability to stay in the home longer.  Offering a loan modification only on rate and term only quells the bleeding for a short time.  It is not a cure.  Besides, if there is a foreclosure, the second lien holder is most certainly wiped out anyway.  So why does Mr. DeMarco feel that principal reductions on GSE loans are tantamount to a bank bailout?  I suspect that he feels the write-downs would be treated as more reason to support the banks with taxpayer dollars.  The answer to this problem is not to further punish homeowners, but, to improve transparency in reporting losses from a regulatory perspective.

But, I think a bigger TARP question remains unanswered.  Regardless of the type of modification transaction, why are full appraisals not required on any government-incentivized homeowner relief programs?  Many argue that a modification of just the loan terms is a risk change limited to the investor who holds the note.  But what about the borrower’s right to informed consent?  Are distressed homeowners just so overwhelmed that relief at any cost is worth it?  And on the flip-side, what is the impact on the local market when such loan modifications are executed?  Should the home values on purchase transactions in those markets be affected?   Can the appraiser adequately reflect the impact of homeowners who ”re-upped”?   Without a lien amount change, can the market really determine how vested the homeowner is after the modification?  Certainly, three sales and three listings will not tell the whole story.