An agreement with the two government-owned mortgage giants to write down so-called underwater loans could reduce the threat to the U.S. housing market from the glut of homeowners believed at risk of default should their personal finances or home prices worsen. A deal would deepen losses at Fannie Mae and Freddie Mac, which already have cost taxpayers about $134 billion.
Fannie Mae and Freddie Mac, which own or guarantee about half of all first-lien mortgages in the U.S., have been highly reluctant to reduce loan balances, especially for borrowers who are still making payments.
Federal officials estimate that 500,000 to 1.5 million homeowners could benefit from the program—a fraction of the estimated 11 million borrowers who were underwater as of June 30, according to CoreLogic Inc. That figure represents about 23% of all U.S. households with a mortgage.
Industry executives say the FHA program—as well as a related initiative by Treasury—will be only marginally helpful to the housing market without the participation of Fannie Mae and Freddie Mac. The program completed three loan modifications during its first three months and received 61 applications
Participation by Fannie Mae and Freddie Mac would put additional pressure on the nation’s biggest banks to follow suit. Banks have shown little enthusiasm for the programs without the two mortgage giants.
David Stevens, the FHA’s commissioner, said resistance by lenders has been exasperating. Obama administration officials have given lenders “a responsible way to address borrowers with negative equity, he said, “and if institutions are blatantly refusing” to participate, then that is “short-sighted.”
The arm-twisting is the latest sign that loan-modification efforts aren’t doing enough to address the threat that more borrowers will default on so-called underwater properties.
“Letting the status quo continue is going to be much more expensive than people think,” said Kenneth Rosen, a professor of economics and real estate at the University of California, Berkeley. “We’ve got a downward spiral in housing here, and they’d better break the back of this with some shock and awe.”
The ongoing discussions underscore the sometimes awkward relationship between the Obama administration and FHFA, which has overseen Fannie Mae and Freddie Mac since their takeover in September 2008 and is charged with stemming taxpayer losses. An FHFA spokeswoman said participation in the FHA and Treasury loan-modification efforts is under review.
The two mortgage companies rarely reduce loan balances—only 10 of the 120,000 loans modified during the second quarter of 2010, according to the Office of the Comptroller of the Currency.
“We have historically counted on the fact that the vast majority of borrowers-even borrowers who are underwater-continue making their payments,” said Don Bisenius, a Freddie Mac executive vice president.
Fannie Mae and Freddie Mac are reluctant to reduce principal because it limits their options to recoup losses. Typically, the companies collect claims from mortgage insurers or force banks to buy back certain loans when a loan defaults. Those options are relinquished when writing down loan balances.
In addition, Fannie Mae and Freddie Mac, along with other mortgage investors, are reluctant to approve principal reductions if banks that own second mortgages on the same properties also don’t take losses.
Unlike most loan-modification efforts, the FHA program is open only to borrowers who aren’t behind on their payments.
The Treasury Department initiative to reduce loan balances builds on HAMP, in which banks reduce monthly payments for distressed borrowers by lowering interest rates and extending loan terms.
Starting in October, banks were able to receive additional subsidies if they first write down loan balances for borrowers owing at least 15% more than their home’s current value. Fannie Mae has said it won’t participate in the Treasury program. Freddie Mac says it is still reviewing whether to join.