Did the Federal Housing Finance Agency (FHFA) make the right decision by banning cramdowns?
- No (60%, 125 Votes)
- Yes (40%, 85 Votes)
Total Voters: 210
The Federal Housing Finance Agency (FHFA) recently announced that it will not allow Freddie Mac or Fannie Mae (Frannie) to offer principal reductions, also known as cramdowns, to underwater borrowers. This is despite the potential economic benefits resulting from such action, and a request directly from the Secretary of the Treasury, accompanied by an offer to pay the agency up to 63 cents for every dollar forgiven.
Edward DeMarco, the FHFA acting director is the main proponent of this decision. He acknowledges that while cramdowns could potentially work, they are rendered impractical due to the expenditure of time and money required of servicers to implement them. He believes that Frannie is doing enough through loan modification, which simply defers payments on the original balance rather than forgiving it to make the homeowner solvent.
According to the agency however, taxpayers would potentially save a total of $1 billion and Frannie stands to save a sum of $3.7 billion by participating in the administration’s housing program. DeMarco believes this to be a pipe dream. He argues that successful implementation of the program will not result in as much savings as the numbers suggest. Further, the agency fears the potential complications of such a program: negagtive-equity homeowners who were previously paying may begin to strategically default en masse, in the hopes of obtaining debt forgiveness for themselves, a feared potential response known as moral hazard.
This decision was reached in spite of a number of critics, primarily comprised of law-makers and economists, who see principal reductions as the only means of relieving pressure on underwater borrowers and stimulating movement in the housing market. Those supporting cramdowns believe debt-forgiveness is the way to greater economic stimulation and that DeMarco is ultimately mistaken in his choice made on behalf of taxpayers’ best interests. These critics have begun to call DeMarco’s authority into question saying he has overstepped his boundaries in opposing federal directives.
first tuesday insight
first tuesday has been an ardent supporter of cramdowns since the beginning of this debate. Cramdowns return principal balances to match the fair market value (FMV) of underwater homeowners, thus leading to a virtuous market cycle of sustainable homeownership and healthy sales volume.
Cramdowns, as most all real estate licensees know, free these homeowners up from negative equity bondage allowing them to put their money back into the economy (and even sell their home without the FICO score taking a hit and killing a replacement home sale) rather than sinking it into a black hole asset.
The FHFA, with Ed DeMarco at the helm, is guilty of turning a sound economic strategy into a political debacle. DeMarco is unwilling to play ball because of his perceived moral hazard of potential strategic defaulters. His motivation for rejecting the program appears to be due to a political stance rather than based on the analytical work of FHFA, which is not what DeMarco was hired to do. As this real estate’s lesser depression continues, strategic defaults will become the norm due to frustration over sales price recovery (which is years away).
But the question remains: is the inferred moral hazard truly an issue? The 1980s saw a successful use of cramdowns in order to relieve distressed farm owners. Bankruptcy courts were given power to grant cramdowns and help underwater farmers pay off the remainder of the debt owed on their properties.
There was significant opposition to the cramdown in that day and age as well. Yet, the mere threat of judges evaluating and cutting principal encouraged lenders to work out loan modifications for their borrowers.
The interesting item to note is that the FHFA’s own analyses of cramdowns prove to be beneficial in the economic long run. The benefits of cramdowns drastically outweigh the costs posed by instituting the program and accounting for any potential strategic defaulters. The moral hazard is nothing more than a rhetorical ploy to keep money in banks’ hands. Reason and history show that principal reduction is the surgery needed to cut out the negative equity tumors homeowners face and that it does not lead to a surge in strategic defaults. The FHFA is just giving out lollipops promising that things will be better. Eventually the people will figure this all out, but the community will be set back years of potential in the process.
Re: Fannie Mae, Freddie Mac won’t be allowed to reduce loan balances for troubled borrowers from The Washington Post. Regulator Rebuffs Obama on Plan to Ease Housing Debt from The New York Times. Fire Ed DeMarco from The New York Times. More DeMarco from The New York Times.