Last week, when Ed DeMarco rejected principal reductions on Fannie and Freddie loans, Treasury Secretary Timothy Geithner pronounced himself disappointed. Housing advocates called for DeMarco to be fired; I explained why that won’t happen. And here’s another reason, courtesy Joseph Cotterill. The truth is that the Treasury Department has all the tools it needs to force compliance in any principal reduction program. They have plenty of power that, to this point, they have chosen not to use.

This comes from the fact that Treasury has a substantial investment in Fannie and Freddie, and thus can dictate terms based on this debt. This idea comes from Ralph Axel of Bank of America:

The FHFA’s decision also underscores the fact that the GSEs are not government agencies; they are private companies that have been temporarily taken over by their federal regulator whose specific mandate is to conserve their assets and continue their activities. As private companies, the GSE will likely respond to economic incentives. The Treasury’s power to modify the terms of the US$19bn dollar annual dividend that Fannie and Freddie (combined) owe to the Treasury is a tool of tremendous strength that could provide one such incentive.

The Treasury has the power to lower the dividend or tie it to incentives. It can tie the dividend to principal reductions or to easier underwriting standards or reduced putback activity to stimulate refinancings and new loans. The US$19bn dwarfs the US$3.6bn savings that the FHFA found from principal forgiveness. This is not housing finance reform, but it is a way to create effective temporary stimulus without raising additional federal debt while simultaneously moving toward larger structural changes.

Treasury, in other words, could play hardball with FHFA and force principal reductions or virtually anything else they want, as a condition of the lifeline they continue to hold out for the GSEs. This would be an aggressive strategy, to be sure, but it’s imminently available to them.

And the fact that they are not making these conditions tells you a lot about whether or not the objections at Treasury to DeMarco’s decisions represent something real or something convenient for the election period. Geithner may be pinning the blame for the continued problems with underwater borrowers on DeMarco to deflect criticism away from the Administration. But he’s unwilling to do anything about it. And that tells the tale.