One of the big arguments against Gretchen Morgenson’s quasi-defense of Ed DeMarco and the implications of principal reductions on Fannie and Freddie loans was that surely nobody is suggesting that the GSEs write down their primary loans while the second liens are kept intact. But in fact that is the argument, according to DeMarco himself:
The US regulator overseeing state-controlled home loan financiers Fannie Mae and Freddie Mac has said that the companies are being pushed to accept losses to keep big US banks from writing down their holdings.
In an interview with the Financial Times, Edward DeMarco, acting Federal Housing Finance Agency director, said policy makers who are pushing his agency to allow Fannie Mae and Freddie Mac to reduce borrowers’ mortgage balances, are deliberately shielding big banks from taking losses on distressed housing debt.
During the US property bubble, US banks gave loans to borrowers who used the equity in their homes as collateral. But when the property bubble burst – homes in the US have lost a third of their value since 2006 – millions of homeowners with so-called “second mortgages” found themselves deeply underwater.
Now, as the Obama administration, Congress and at the Federal Reserve call on Fannie Mae and Freddie Mac to write down the mortgages they own or guarantee, Mr DeMarco argues that such a move amounts to a transfer of US taxpayer wealth to the biggest US lenders, whose “second mortgages” are subordinate to the debt owned or guaranteed by Fannie Mae and Freddie Mac.
“If you do principal forgiveness, who is it benefiting?” Mr DeMarco asked. “Doing principal forgiveness is what would protect the big banks.”
So this is not Morgenson’s novel argument, but something DeMarco believes as well. And it must be jarring to the advocacy community to hear this man, who has been villified as a tool of the finance lobby, talking about protecting the big banks.
DeMarco hasn’t answered why he won’t move to principal write-downs on Fannie and Freddie-backed loans that have no second attached. He just seems to like interest rate cuts or principal forbearance better. I don’t agree and I think the numbers on correlation between negative equity and eventual foreclosure bears that out.
The important thing here is that this is not necessarily an either/or but a both/and. DeMarco could endorse write-downs where it makes sense for both borrower and lender and where the second problem doesn’t exist; that is probably a lot of loans, though we don’t have exact numbers. It’s appalling that we don’t have good data on how many loans that would be; even Dean Baker is just guessing.
Alternatively and in tandem, the Federal Reserve or the OCC could simply mandate that second liens on significantly underwater homes get wiped out whenever principal gets reduced on first liens. That would restore lien priority and not create problems of borrowers still being underwater when you factor in the second. Additionally it wouldn’t transfer the hit from the banks to the investors. The Fed or OCC could do it by fiat. This way, all underwater loans are accounted for, seconds or no seconds.
But the best evidence that the Administration doesn’t want to do this is two-fold. First of all, they put into the settlement a provision where seconds only get written down in equal terms to the firsts, a breach of contract. Second, you have William Dudley of the New York Fed saying this directly:
William Dudley, president of the Federal Reserve Bank of New York, is among the most public proponents of debt forgiveness by Fannie Mae and Freddie Mac. Some critics say that the New York Fed and other regulators responsible for the health of the biggest US banks are protecting them from demands that they write down their holdings.
Meanwhile, the regulators who are responsible for the health of the biggest US banks are careful not to be too aggressive in demanding that the lenders write down their holdings out of fear for the banks’ solvency, observers have said.
In January Mr Dudley said that Fannie and Freddie should reduce mortgage principal for the greater good of the US economy, even if the associated second mortgages are not touched.
Mr Dudley said that because regulators are unable to match first mortgages with the underlying second mortgages, policy makers – including Mr DeMarco – should nonetheless pursue loan principal writedowns.
This isn’t true, according to OCC data, which says that as of two years ago, they had matched over 60% of the second liens to the primary debt on the property.
The point is this. Most of the second liens are owned by the big four banks: JPMorgan Chase, Bank of America, Wells Fargo and Citigroup. They total hundreds of billions of dollars. And Administration policy says that those banks shouldn’t take the hit, even on loans that are significantly underwater.
Some would ask why I care who takes the hit, as long as homeowners get help? There are a couple larger issues. One is that investors getting continually screwed means they will continue to abandon a private securitization market that, when it works, increases available capital and gives a new generation of people access to mortgage finance. The second is the Simon Johnson argument – until you break the power of the oligarchy, you will not have a recovery, you will have cascading financial crises, and you will not have an America that reaches its full potential.
While the banks got bailed out, homeowners did not – the fundamental finding of a massive National Journal story on housing policy. The Administration simply did not want to help the homeowner in any way that imperiled the recovery for the banks. It has animated policy. It stopped cramdown. It stopped work on untangling the second lien mess. It made HAMP discretionary rather than mandatory, as a condition of the bank bailout. It created a settlement that has a characteristically light touch.
So nobody should be surprised by a worldview, even at this late date, where a policy deemed helpful to homeowners needs to also help banks.