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A Qualified Defense of DeMarco, the Administration’s Favorite Scapegoat for Its Failed Housing Policies (Updated)

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There’s been an interesting contretemps over an article by Gretchen Morgenson over the weekend, “A Bailout by Another Name.” Morgenson made the hardly-controversial observation that writing down Fannie and Freddie first mortgages without wiping out any relate second is a back door bailout. Remember, this was one of our key objections to the bank-friendly mortgage settlement, that a requirement to write down firsts and only write down related seconds to a degree is a subsidy to banks when if you were to believe the PR, the settlement is supposed to redress past abuses.

Morgenson also defends DeMarco’s refusal to do principal mods on Fannie and Freddie loans, arguing that he is subject to a requirement to preserve taxpayer assets and that the studies on this have been inconclusive. She adds that the focus is again incorrectly on Fannie and Freddie and not the banks. HAMP mods on GSE paper appear to be roughly proportional to their market share of original lending (around 40% before the crisis) when given their much lower default/delinquency rates, you’d expect them to represent a smaller share than they do relative to mods of bank owned and private label securitized loans.

The fact that this article has gotten heated responses from Felix Salmon and Dean Baker appears to be more a function of tribalism of various sorts than about the policy issues at hand. DeMarco has become a favorite whipping boy of the Democratic party so as to distract from its abject failure to come up with remotely adequate solutions to the housing mess. And Morgenson fingers what has been the Administration’s continued top priority, that of protecting the banks.

Mind you, we are not opposing principal mods on GSE paper. This does not have to be a policy either-or. Second liens should be wiped out for stressed borrowers and principal mods made on first mortgages when the borrower looks to be viable on a lower level of mortgage payments. But as we have discussed at length in other posts, the banks’ defense is that the delinquencies on their seconds are low. That’s by virtue of the fact that banks can make home equity lines of credit look current, either by increasing the credit line so the borrowers can use more bank money to make the payment, or making them look current via putting them on negative amortization and accepting minimal payments.

But all of this noise about GSE principal mods is really a smokescreen. DeMarco has become the Administration’s favorite scapegoat as a way to divert attention from the it’s refusal to get tough the banks in order to fix the housing market. Among the obstacles to a real estate recovery: a broken servicing model, in which servicers find it more profitable to foreclose than modify loans; second liens on bank books at inflated values; rampant chain of title issues; a huge overhang of foreclosures in progress.

If the Administration wanted serious principal reductions, they could have used the hundreds of billions of dollars available to them under TARP to do so. That was under its power and required no Congressional action. Instead of owning up to disasters like HAMP and FHA-Short Refi, they whine about Demarco, Republicans in Congress, reckless homeowners, and once in a while, for show, they’ll say a few bad words about the banks that they continue to coddle. Just look at the conflicting messages: the banks are in such bad shape that they can’t be asked to write off second liens in full in the Administration’s mortgage settlement, yet they are deemed to be healthy by the Fed and are allowed to pay dividends rather than rebuild their balance sheets.

And consider the latest bank gimmie, as reported by the Associated Press (hat tip reader Deontos):

Banks participating in the Obama administration’s expanded mortgage refinancing program are able–and willing–to charge higher mortgage rates than normal, according to an analysis by Amherst Securities.

The investment firm points out that under the revised Home Affordable Refinance Program–often called as HARP 2.0–banks receive special benefits for refinancing their own loans, meaning that borrowers are likely to stay with the same lender if they want to refinance. As a result, banks have “tremendous pricing power” that they’re taking advantage of “by charging higher rates to HARP borrowers and…earning massive profits on originations,” Amherst concludes in the new research note…

Amherst suggests, however, that there’s a simple way for the administration to expand refinancing at more affordable rates: “Increase HARP refi competition by providing the same benefits on a different servicer refi.”

But despite the bending-over-backwards to the problem, Democrats pound on the “fire DeMarco” message when that isn’t a solution to their perceived problem. From The Hill:

[Barney] Frank was also quick to concede that replacing DeMarco is no guarantee the Federal Housing Finance Agency (FHFA) would adopt the more aggressive foreclosure-prevention policies DeMarco’s critics have urged.

Instead, because Senate Republicans would likely block any permanent replacement President Obama nominated, the White House would be required, by law, to seat one of DeMarco’s top FHFA deputies – officials who support DeMarco’s strategies, Frank said, and would likely continue the same foreclosure policies that have so angered Democrats and housing advocates.

If they got rid of DeMarco they’d have to replace him with one of the other three [FHFA] division heads, who’d be the same as him, Frank said. The president could only replace DeMarco with somebody who would be probably more rigid than DeMarco.

Now let’s turn to a second level tribalism which in on view in Felix Salmon’s attack on Morgenson. Felix has long been a Morgenson-basher, jumping on her regularly when she’s made minor errors in her pieces (see here, here, here and here for past examples). At the same time, he’s also a big promoter of ProPublica, which appears to be acting as a mouthpiece for the Administration or its allies on Fannie and Freddie. ProPubilica ran an astonishingly bad piece on Freddie Mac’s use of inverse floaters and refused to back down even after a number of finance professionals pointed out how wrong they were (see here for more detail).

Let’s look at Felix’s hatchet job:

She starts off by painting DeMarco as a “career public servant”, “under fire” in a “thankless job”. This is a phrase she seems to reserve for DeMarco alone: she made sure to describe him as a “career public servant” in 2010, as well as in her book. And as far as I can tell, she’s described no one else that way. And there are many career public servants, up to and including Tim Geithner, who can’t stand DeMarco* and who think he is being deliberately obstructionist here.

Yes, sports fans, he means this in all seriousness. I’ve spoken to people who’ve known DeMarco for decades and describe him in precisely the terms Morgenson uses. And I’ve been hearing tales of Geithner’s frustration at his inability to bring DeMarco to heel (I derive great pleasure at the idea of Turbo Timmie being stymied). Given Geithner’s abject fealty to a banks uber alles policy and his lack of real interest in the housing market, it isn’t hard to imagine that anyone who might have the nerve to have a different point of view and be positioned so as to block him would be depicted as “obstructionist”. And the “thankless” label is apt. Would you like to be pounded in the press and hectored by the Administration and Democratic Congresscritters on a daily basis?

Felix then puts his foot in mouth and chews for five paragraphs, arguing vehemently that reversing the lien hierarchy and writing down firsts owned by Fannie and Freddie and leaving bank owned seconds intact is not a transfer to the banks. Felix sputters that Morgenson can’t prove how often a bank held second lien sits behind a GSE mortgage, but that’s typical of how bad mortgage market data is (ie, estimates on anything, even something as basic as how many homes in the US have a mortgage on them, vary by the millions). Shahien Nasiripour notes in the Financial Times that the OCC has been able to link seconds to first for 60% of the second liens. That’s progress, but it’s far short of complete.

Remember, it’s bank owned servicers who have been in charge of administering modification programs. As we’ve written, they’ve already proven to be adept at gaming various systems, from HAMP to routinely ripping off borrowers and investors in the way they service loans to impermissibly modifying first liens on Countrywide-owned loans when the bank held a related second in over 200 trusts (this was Bill Frey of Greenwich Capital’s data, confirmed by Fannie). The evidence is overwhelming that banks will cut themselves the biggest piece when they have the right to do so, and they’ve done it even when they in theory don’t and have gotten away with it.

Felix argues that Morgenson’s first v. second lien issue is a straw man. Huh? He also seems remarkably unaware of the well-documented role second lien holders have played in blocking mods of first liens that would require the second to be written off. Policy advocates may choose to ignore that, but until regulators force banks to write down non-fully-amortizing seconds, this sort of nonsense will continue. Felix finally says that one option would be to limit GSE principal mods to homes without a second lien. That does solve the conflict conundrum but leave many of the most stressed borrowers with no help, since delinquency and default rates are much higher for borrowers with first and second liens than those with firsts alone.

Felix also makes some baseless arguments, for instance, that if modifying firsts without touching seconds were such a bennie, you’d see bank lobbying. How does Felix know that there isn’t bank-driven pressure on this end? We see it in the indefensible partial preservation of seconds when mods are made on firsts in the mortgage settlement and in the OCC’s refusal to make the banks mark their seconds more realistically. But a guy like Geithner running interference also reduces the need for overt pleas.

Similarly, he charges DeMarco with having a religious zeal against principal mods. But where is the proof for this charge? DeMarco maintains that he is still analyzing the matter and will reach a determination in a few weeks and has said he’d do them now if Congress passed appropriate legislation. He’s not opposed to borrower relief; the Financial Times notes:

Last year, two-thirds of the companies’ 322,000 loan modifications involved reductions in monthly payments by at least 20 per cent.

Principal mods could get you to higher levels, but 20% is not bad. And Felix’s dismissal of the second lien issue is remarkable. One colleague is just back from Europe, and he say between the bad origination and the mortgage settlement, no foreign buyer will ever consider buying US private label mortgage paper (I’d hazard in practice that means ten years, memories are remarkably short in investment land).

Dean Baker’s critique was more moderate in tone but some of his arguments are so strained as to be disingenuous. For instance, he says that Corelogic estimates that 60% of underwater mortgages have second liens. Aside from the fact that some of Corelogic’s past estimates (or subprime losses) and current ones (of shadow inventory) are dubious, underwater mortgages are not the relevant data set. Unless DeMarco gets his conservatorship mandate relaxed, he can only modify mortgages where there is a current or imminent risk of delinquency or default.

He similarly argues that DeMarco does not appear to have tried to negotiate with banks over wiping out seconds. Baker as a housing market expert has to know of the blocking role second lien holders typically play in mods. It’s astonishing for him to pretend that he doesn’t know about this well established practice. Now if he’d argued that DeMacro might be able to document this, shame them, and eventually bully them into compliance, that would be different. But if you think DeMarco was under Administration pressure now, it would escalate if he put the caliber of bank second liens into question.

Finally, Baker straw mans Morgenson:

Morgenson offers up a defense of DeMarco’s conduct by noting that foreclosure rates are much lower on F&F loans than on the loans held by banks or in private issue mortgage backed securities. While this is undoubtedly true, it should be expected given that the loans issued by F&F were much higher quality than the loans that were placed in private issue mortgage backed securities.

Since F&F stayed away from the worst subprime and Alt-A mortgages they naturally would have lower default and foreclosure rates on their loans. This is not evidence that they have been especially effective in their modifications.

Morgenson cited the lower Fannie and Freddie default rates to make the point the most of the mortgages in trouble weren’t the ones issued by GSEs. She was not using that statistic to comment on the effectiveness of their mods (how could it? It’s irrelevant). And she did say this later:

According to a recent report from the Office of the Comptroller of the Currency, loan modifications by Fannie and Freddie have performed far better than those on privately held mortgages. Since the taxpayers took over the companies, re-default rates have been consistently lower at Fannie and Freddie than among privately held mortgages, the report shows.

Mind you, I’m not saying DeMarco deserves applause. It is highly likely that he lacks independent analytical capacity at FHFA and he has apparently been presented with less than conclusive analyses from the GSEs. Principal mods should be something that Fannie and Freddie uses to help salvage stressed borrowers. The question is under what circumstances and what any program parameters should be, and those are not trivial issues.

But the flip side is the pressure on DeMarco has little to do with doing the right thing, and pretty much everything to do with the perceived need to have Potemkin “help borrower” programs for every type of struggling homeowner. In this beauty contest between two of Cinderalla’s ugly sisters, it should be obvious which one deserves your vote, and it isn’t Team Obama.

Update 11:00 PM. Dave Dayen has an important story on the continuing ProPublica attack on Fannie and Freddie that Felix cited in his post. The ProPublica article claimed that there was a new analysis that said that principal mods would save taxpayers money. Dayen demonatrates that that’s false (“bullshit” to be precise). Further proof that ProPublica is taking dictation from the Administration or its friends.

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18 comments

  1. Capo Regime

    FHFA used to be called OFHEO. Back when it was OFHEO it had a particularly good leader in Armando Falcon who went after both Freddie and Fannie. he went after them and Bush fired him. Lot of democrats were upset at him (a very capable lawyer regulator who one his stripes working for Henry B. Gonzales the last honest member of Congress) as well. Has not been anybody half as good as Mr. Falcon since he was squeezed out for being honest. Ives should interview him or give him the coverage he warrants as one of the few honest men in D.C.

      1. Capo Regime

        Yep, there it was laid out clearly back in 03. But of course all the pundits and officialdom where as always “surprised”.

  2. Oh Please

    Why have DeMarco defended at all, he can prattle about taxpayer this n’ that and then quietly retire. He shouldn’t have anything to do with housing people.
    To homeowners, who live in their one and only insanely inflated broken down ranch, the ability to come before a Bankruptcy judge and have the value returned (adjusted, crammed down, modified) to pre-fraud levels is sensible, not to mention humane, and would be simply restoring what the Banksters stole in their earlier re-writes of the law in their favor. Gretchen is in this sense, perpetuating a distraction, the same way a political hack would claim injury to “taxpayers” to obfuscate how important it is to maintain the enmeshed gears of kleoptocracy.

  3. Mark P.

    Yves: ‘I derive great pleasure at the idea of Turbo Timmie being stymied’

    Perhaps immature on my part, but I am so with you on that.

    In this disaster, there are figures who arguably are limited characters playing a bad hand as best they can by their lights: Bernanke, for example, who’s criticized the politicians for playing austerity games, may be one of these.

    And then there are the active malefactors who, while masked as public servants, have tirelessly served the financial industry at the vast, vast expense of the society as a whole: Geithner and Summers and certain other individuals.

    Scum.

  4. Richard

    Yves,

    Excellent post.

    No foreign buyer will consider a) buying a US private label mortgage backed security again or b) buying a US mortgage backed security again?

  5. freedomny

    “Morgenson made the hardly-controversial observation that writing down Fannie and Freddie first mortgages without wiping out any relate second is a back door bailout.”

    As an ex-Chase mortgage banker, I can assert that Chase “strongly” “advised” that prime mortgage originators attach a heloc to 80% of originations. I can also assert that there was an environment of “subtle” “threats” if such advice was not taken seriously.

    Ironically, the executive in charge of the home equity department, was promoted after the department exploded, losing Chase bundles of money.

    He’s still there….

    So much for corporate meritocracy.

    1. just me

      I hope Yves reads this comment:

      http://news.firedoglake.com/2012/03/26/demarco-confirms-second-lien-issue-in-principal-reductions/#comment-181608

      Mary4 March 26th, 2012 at 8:09 am 2

      Well that is comforting, they have managed to connect the second liens with the first liens, I have a hard time believing this 60% number. I stated before I have seen two instances whereby the second lien was not subordinate to the first. (I was not even looking, I stumbled on them). When I thought about this further I realized this was probably intentionly done to deceive the Investor. Since no one relys on the county recording systems and they can’t rely on MERS, this is just a free for all. Anyone wanting to foreclose on any home can just do it. Make up the assignments, reconveyances, satisfactions. The judge approves all the junk and the bank owns another house. The title companies are great about this too, they just accept all the junk.

      Second lien not subordinate to the first? Huh?

  6. Paul Tioxon

    Ed Demarco stands in the way of writing down F&F 1st mortgage for a reason that I can see, but may not be clearly articulated. All leans on residential real estate are recorded and satisfied by date. So, a 1st mortgage is recorded as a lien before the second. A HELOC from a bank, brought on by the homeowner is in the second lien position, usually because it is added after the home is purchased. If the homeowner refis the first, back in the good old days, the 1st and 2nd were combined into a new single 30 conventional loan product from F&F, and the two old ones were paid off, marked as satisfied. There would then be one and only one lien recorded, bigger than any before that should all be marked as satisfied.

    If Ed Demarco were to modify any lien in the 1st position, marking it as paid off, satisfied and then replacing it with a smaller loan, whatever 2nd mortgage there was would automatically fall into 1st lien position. And the F&F loan would be in the 2nd lien position.

    In the good old days, you typically requested and received a subordination letter from the second lien holder, if you were not paying them off. That meant they were giving written notice that they were allowing the new lien to be recorded in a senior position, simply, allowing the new loan to be the 1st lien. That was sometimes the fly in the ointment, but many a mortgage broker wheeled and dealed until the subordination letter came through. Needless to say, no underwriter for a convention F&F loan was approving a loan for closing that would immediately fall into 2nd lien status.

    It is a matter of record that servicers are most uncooperative for most of the programs to held homeowners, but that is because most of the programs seem to written by people who never took a loan through the approval process. It would seem to require a suspension of all expected behavior on the part of disinterested processors who know that they have been tasked with the impossible.

    I can only hope that Demarco or anyone else understands this. This is not a controlled GM bankruptcy with a judge suspending all previously known practices.

    Fannie and Freddie Mac are two big multi $TRILLION targets, like Social Security that are under attack. Gretchen’s recent book, “Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon” seems to lead an armored division in the war against middle class home ownership. Apparently, the end of the world was caused by lobbying for underwritten, convention 30 year mortgage products, that did not deliver 100% financing. That would be sub-prime. Please see Magnetar on that issue.

    I don’t follow the fine resolution as you do Yves, but Gretchen is part of the confusion and misdirection machine. I am not sure exactly what the due process would be to write down the crap that is exclusively F&F 1st mortgages, but without wiping out 2nds, and any other crap on title, like home improvement loans from window and siding or pool installers, I don’t see how you can modify the first. Now, during the bad old days, the increasing equity allowed for a lot of debt that can not just be made to go away, because it is not connected to just one creditor. It is more like a bankruptcy.

    Finally, on this site there has been much discussion in the past about writing down all of this stuff. The bad bank? Jubilee? Etc etc. How can any of these problem loans be resolved without investors, taking a hit? Whether or not the banks take a hit, and they can hold onto to their 2nd position until they are wiped out by the foreclosure process or Chapter 7, if there is a possible program that everyone can get on the same page, investors will take a hit with or with 2nds. If the primary aim is to resolve the problem and the intended or intended consequence is to some how help out the banks who happen to have a 2nd, and left whole, the structure of lien recording makes this an unavoidable ancillary effect of doing anything with the 1st, not a knowing and deliberate attempt to help the banks. Like capitalism, there are a lot of inherent contradictions coming to the foreground, that were not planned or desired, but the just the way things work. Systemic, there is a reason why when things to go to hell there is no place to hide. Systemic risk is also on the immediate level of the homeowner who has no place to go when buying a home, than the world that we live in as it is.

    1. Yves Smith Post author

      I read Reckless Endangerment differently than you do. I think she’s not great at writing precisely and particularly not good at imposing a structure. RE was a very awkward cross between a narrative and an argument book. She didn’t make clear what the argument was, but it sure seemed like there was one, and it was all about the political model that Jim Johnson created doing lots of damage.

      So I think the strong narrative/weak structure created a huge Rorschach: people projected their particular likes and dislikes onto the various stories she pieced together.

  7. LucyLulu

    I haven’t heard any updates lately, if there have been any, but don’t forget that DeMarco filed the 17 lawsuits against the banks and some of their executives. That’s more than anybody else in DC or state capitals have done. Surely that didn’t win him any brownie points with the Administration and the DOJ. It was a pretty balls-y move and he hung in there with getting his subpoenas and discovery requests answered, no trivial task when dealing with the banks who are infamous for ignoring them. He even used his federal prosecutorial powers and went into the banks and did on-site full loan audits. Also he is enforcing putbacks upon cancellation of mortgage insurance at Fannie, and I assume the same at Freddie when that contract comes up for renewal. While I may personally be in favor of writedowns, and for all we know, DeMarco is too, in his role as conservator, the only way that DeMarco can approve the writedowns is if they will end up a net gain for the US taxpayers.

  8. Jim A

    It’s possible that DeMarco is playing a deeper game here. In foreclosures most of the seconds are wiped out. Whether the FB is “current” on them or not is irrelevant to how the proceeds of the foreclosure sale. The only real value of these loans is the ability to prevent the first from being refinanced into another first. So for those lenders, the question is: how much would the GSEs prefer mods to foreclosure? The more it’s worth to the GSEs, the more “go away” money the owners of 2nds can demand. By being “uninterested” in mods, DeMarco might be trying to lower the costs of making the 2nds not block mods.

  9. Eric377

    What’s wrong with foreclosure? The borrower gets the ultimate improvement to their balance sheet and the hierarchy of creditors is respected. Any lender, including Uncle Sam via F&F, has to be keenly aware that what might make sense for one loan in isolation can have devastating impact on the portfolio if it becomes viewed as an entitlement. If F&F ever launch on this they will become enmeshed in a political and legal morass of astounding proportions. And since F&F is simply fronting the US Treasury, it is going to take about 10 seconds for home borrowers with non-F&F creditors to demand equal treatment. And shortly after that people without mortgages are going to line up for compensation of lost equity. Then students are going to want a nice wad to put student loans on a more payable basis. We need DeMarco to hold the line until Congress and the Administration clearly put the needed money behind these deleveraging efforts…and they are not there yet.

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