Last week the acting director of the Federal Housing Finance Agency, Ed DeMarco, made a familiar argument. He announced that he would not approve the Obama administration’s request that struggling borrowers whose mortgages are backed by Fannie Mae and Freddie Mac receive debt relief through principal reductions subsidized by the Troubled Asset Relief Program (TARP). DeMarco’s refusal was based on his concern that granting such relief would encourage other borrowers to “strategically default” by not making payments on their loan to take advantage of the promise of a reduction in their debt. This is a version of the moral hazard argument we heard about so often in the early days of the financial crisis. Secretary Geithner, in response, argued in a public letter that notwithstanding such concerns, and for the greater good of the overall economy, such relief should be granted whenever it would result in a better economic outcome than foreclosure.
This is not the first time this debate is happening – but last time around, Geithner was the one arguing DeMarco’s points. Although one can argue whether principal reductions are the right way to address the ongoing housing slump – I have championed principal reductions for years but acknowledge that there are passionate arguments on both sides of the issue – no one should be fooled that the administration’s entreaties to DeMarco are anything but political posturing. As I recount in my recently released book, Bailout, during my time as the special inspector general in charge of oversight of the TARP bailouts, Treasury Secretary Timothy Geithner, using the same justifications now offered by DeMarco, consistently blocked efforts to use TARP funds already designated for homeowner relief through a principal reduction program that could have a meaningful impact on the overall economy.
For example, in 2009, $50 billion in TARP funds had been committed to help homeowners through the Home Affordable Modification Program (HAMP), a program that the president announced was intended to help up to 4 million struggling families stay in their homes through sustainable mortgage modifications. Hundreds of billions more were still available and could have been used by the White House and the Treasury Department to help support a massive reduction in mortgage debt. But Geithner avoided this path to a housing recovery, explaining that he believed it would be “dramatically more expensive for the American taxpayer, harder to justify, [and] create much greater risk of unfairness.” Treasury amplified that argument in 2010, after it reluctantly instituted a weak principal reduction program in response to overwhelming congressional pressure.
Exactly. Geithner has used the moral hazard/strategic default argument plenty of times over the past few years. Now it could be that Treasury has magically turned the corner and gotten the message that the economy needs widespread debt relief. But the fact that this lines up perfectly with the upcoming Presidential election is enough to make one skeptical. And if that’s not, then how about this:
The Federal Housing Administration, a separate agency that is part of the Department of Housing and Urban Development, has nearly 720,000 mortgages that are three months or more past due […] About 31% of FHA loans were underwater at the end of last year, compared with roughly 22% of those outside of the FHA, according to CoreLogic.
That would seem to make that agency a contender for the kind of principal forgiveness many would like to see Fannie and Freddie undertake. Federal law, for example, appears to allow the FHA to offer a form of forbearance, in which up to 30% of a borrower’s loan balance is set aside with no payments required. The HUD secretary also has authority to forgive that debt at any time thereafter, though officials say it isn’t clear they have the legal authority to let borrowers stay in their houses when that happens.
Administration officials say there are other legal hurdles to the FHA more broadly engaging in principal forgiveness, many that could require congressional action. That said, there hasn’t been any apparent attempt to overcome such obstacles.
Maybe those hurdles are legitimate and maybe they’re not. But you have to go back to the track record. Treasury did not initially include a principal reduction alternative in HAMP, added it late in a way designed so no servicer would have to actually grant principal reductions (because the decision was entirely up to them and not mandatory when the statistics showed a benefit to the loan holder), and only at the tail end encouraged Fannie and Freddie to reduce debt on their portfolios. Even now, despite calls in many circles to fire Ed DeMarco and replace him with someone who would carry out this agenda, we’ve gotten nothing more from Treasury but a sternly worded letter.
It’s not like DeMarco comes out of this looking great either. He’s held Fannie and Freddie up as conservators of taxpayer dollars when acting as tax cheats by ripping off local governments for several billion dollars.
But let’s stop pretending that Tim Geithner and the Obama Administration had a deathbed conversion on principal reductions, and now is being stymied by that mean ol’ bureaucrat Mr. DeMarco. That’s the story the White House would want you to believe. Their inaction and simple retelling of that story gives much of the game away.