Aren’t We All Better Off if Fannie, Freddie Forgive and Forget?

BY Paul Solman  May 17, 2012 at 12:16 PM EDT

Fannie Mae
Fannie Mae headquarters in Washington, D.C. Photo by Flickr user futureatlas.com via a Creative Commons license.

Paul Solman frequently answers questions from the NewsHour audience on business and economic news on his Making Sen$e page. Here is Thursday’s query:

Name: Barbara Seijas

Question: Wouldn’t the pools of investors and Freddie Mac be better off if the principal of mortgages were reduced, rather than leaving foreclosed homes left to rot?

Making Sense

Paul Solman: This question came over the transom long ago. Recently, there was some news to justify an answer to it. As Annie Lowrey reported on April 10 in the New York Times:

The overseer of Fannie Mae and Freddie Mac on Tuesday opened the door to forgiving some mortgage debt of homeowners who owe more than their houses are worth, as the Obama administration has recently urged.

The acting director of the Federal Housing Finance Agency, Edward J. DeMarco, said that in some circumstances it might make economic sense for the government-run companies to reduce borrowers’ mortgages, taking a hit to modify the loan but also making it less likely that a homeowner will default.

But in his speech at the Brookings Institution, Mr. DeMarco described as limited the benefits from principal reduction, saying it would hardly be a magic bullet for struggling homeowners and noting that it might carry significant costs for taxpayers. His comments left doubt about whether he would change his long-held stance against principal reduction.

“This is not about some huge difference-making program that will rescue the housing market,” he said. “It is a debate about which tools, at the margin, better balance two goals: maximizing assistance to several hundred thousand homeowners while minimizing further cost to all other homeowners and taxpayers.”

In a new analysis cited by Mr. DeMarco, the F.H.F.A. found that reducing mortgage principal for about 691,000 eligible underwater homeowners would reduce Fannie and Freddie’s losses by about $1.7 billion, compared with doing another form of loan modification. But the Treasury Department would pay out $3.8 billion in incentives for the principal reductions, meaning a $2.1 billion net loss for the taxpayer.

Now emailer Barbara Seijas might point out to regulator DeMarco that the net loss for the taxpayer will be a lot more than $2.1 billion if houses are left to rot, as some likely will be without principal reduction.

DeMarco might even concede the point, but he would surely add that principal reduction is a slippery slope. If you get a break on your principal, why shouldn’t I? Are we really prepared to reward bad decisions (taking out a loan you can no longer afford) at the expense of those of us who only borrowed as much as we could repay? Would large-scale principal reduction create a “moral hazard” problem that encouraged profligate borrowing (and lending) by holding out the prospect of future principal reductions during downturns?

On the other hand, wouldn’t all Americans be better off if houses weren’t rotting? See our story on Cleveland for this side of the argument.

Watch: Raze the Roof: Cleveland Levels Vacant Homes to Revive Neighborhoods


This entry is cross-posted on the Making Sen$e page, where correspondent Paul Solman answers your economic and business questions