Surprise: Frannie says “no thank you” to cramdowns

Frannie’s morals on principal reduction

While a handful of small lenders have begun to experiment with debt forgiveness arrangements for underwater homeowners, government-owned mortgage enterprises Freddie Mac and Fannie Mae continue to stand by their policy to avoid principal reduction on negative equity home loans.

These small investors and lenders have their hands tied by the two institutions, collectively dubbed Frannie. A home loan cannot qualify for principal reduction – a cramdown – if it has been bought, held or securitized by Frannie, and since the enterprises currently guarantee more than 70% of the nation’s home loans, there is only a small pool of loans which would even begin to qualify for any debt forgiveness program.

With the nation’s total current negative equity estimated at $700-800 billion, principal reduction supporters and critics of Frannie argue debt relief for underwater homeowners is the only way to bring about a return to normalcy in both the housing market and economy. The banks were bailed out, they say, and homeowners deserve the same relief (assuming both the banks and homeowners are persons). Continuing to reject debt relief will only drag out the recovery for years by postponing losses and further reducing the standard of living for these locked-in homeowners.

The two enterprises’ rationale for sticking to their stance against principal reduction? Purportedly, it poses a “moral hazard” for the mortgage business and will ultimately hurt taxpayers. Frannie intentionally stonewalls cramdown arrangements in fear it will suggest future homebuyers can always default to qualify for a principal reduction should they ever run into property valuation problems on a risky loan. Fantasy land at best, whining at worst. [For more information on Frannie’s position against principal reduction arrangements for negative equity homeowners, see the NY Times article Freddie and Fannie Reject Debt Relief.]

Editor’s note – In January 2012, the Federal Housing Finance Authority (FHFA), which regulates Frannie, announced their decision against a recent proposal which would allow both Freddie Mac and Fannie Mae to authorize principal reduction for underwater homeowners. The FHFA concluded cramdowns and other forms of principal reduction were not the most advantageous loss mitigation tool, particularly due to the costs it would incur for income tax payers. [For more information on the reasons behind the FHFA’s decision, see the February 2012 first tuesday article, Cramdowns shot down: another missed opportunity.]

Cramdown plea for California

Frannie is wrong. Very wrong. But all this anti-cramdown policy is no surprise. Any whisper in the mortgage banker’s capitol city about lenders reducing mortgage principal in California has been but small talk. Congressional effort during 2009 to let the bankruptcy courts handle the excessive debt issue of insolvent homeowners was soundly defeated by all mortgage lenders and their insurers – Frannie included on both counts. [For more information on the cramdown rumors, see the July 2011 first tuesday article, Lenders are reducing principal?]

California’s 2.5 million-plus underwater homeowners need relief now: either let them sell and buy, or rent where the jobs are in order to improve their housing conditions. The state’s economy will not recover until the government- and Wall Street banker-driven mortgage and monetary policy of forced austerity currently being pushed down the throats of our homeowner population is ended by adjusting loan balances to property values.

Since recent slow and stubborn lender practices in the last year have put loan modifications out of reach for California’s homeowners with a loan-to-value ratio (LTV) over 125%, the solution to their negative equity is debt relief in the form of a cramdown. It is not a bogus notion as many banks and lenders would have the public believe. Even state attorneys general (AGs) have been pushing to include cramdown provisions in their mortgage settlement negotiations with the banks. Persistent reality aversion from the financial titans is proving difficult to work with, and this was why California’s AG pulled out of national negotiations (action pursued to end attempts by lenders to obtain immunity from any liabilities they might have to their creditor homeowners). California, one of the states hardest hit by excess Wall Street-funded mortgage lending, will now conduct its own investigations of mortgage fraud cases and pursue reforms – including cramdowns – which demand more from the banks for California’s distressed homeowners. [For more information on California’s withdrawal from negotiations with the Big Banks, see the October 2011 first tuesday article, A secession of Californian proportions.]

Faulty lender morality

The opposition will immediately attack the cramdown policy as immoral under the lender theocracy. However, this is an elitist stance based on the rentier-debtor double standard – the Big Banks (the rentiers) can be bailed out in a financial crisis solely of their making while homeowners (the debtors) are left on their own to figure a way out of their financial black hole.

The mis-regulated and misguided mortgage lending programs of lenders was the first trigger to the three-fold increase in California home prices from historical trend-line levels, not the homebuyer’s naive response to the government’s housing policy of a home for every American. Dream on, Wall Street. Your conscience is not exactly clean.

It is a faulty morality being preached to argue the government’s absolution of the banks was just a matter of good business practice, and then spout a breach of the laws of ethics over the idea of the government granting debt relief to homeowners. Government pandering to Wall Street – the future for its banks and its men is not likely to end well. [For more information on the conflict between rentiers and debtors, see the September 2011 first tuesday article, Rentiers and debtors: why can’t they get along?]

Cramdowns, principal reductions – they’re not new ideas. For more information on how they are the viable solutions for underwater homeowners, see first tuesday’s coverage in the:

• September 2011 first tuesday article, Debating for the underwater and underemployed;
• September 2011 first tuesday article, REOs for rent;
• July 2011 first tuesday article, The President tweets his housing mistakes;
• June 2011 first tuesday article, Wobbling housing market reflects wobbling economy;
• April 2011 first tuesday article, Retribution deferred: lenders prove too powerful to be prosecuted;
• March 2011 first tuesday article, Though FHA ‘Short-Refi’ applications increase, program still a failure;
• March 2011 first tuesday article, Mortgage market reform from the executive branch;
• January 2011 first tuesday article, The inconsistent cramdown policy;
• November 2010 first tuesday article, Lenders unwilling to reduce principal balances under California’s ‘Keep Your Home’ program; and
• November 2010 first tuesday article, Mortgage modifications showdown: interest rate reductions v. principal cramdowns.