Today, Acting FHFA Director Ed DeMarco wrote to Congress, after due consideration, reaffirming his position that he will not permit Fannie and Freddie to lower principal balances of mortgages of borrowers that are delinquent. This is despite the fact that the top analyst in this space, Laurie Goodman, has determined that principal modifications are the most effective form of mortgage modification, resulting in much lower refault rates than interest rate mods or capitalization mods. And that makes sense. Why should a borrower struggle to hang on to a home when even if they make all the payments, when they sell they they are stuck with a big tax bill? And as we’ve stressed, private label investors are overwhelmingly in favor of deep principal mods for viable borrowers, and that’s because foreclosure is costly and leaves them worse off.
So it’s more that a bit puzzling to see DeMarco nix principal mods, particularly in light of a Treasury program that provides subsidies to investors of 18% to 63% of the amount forgiven, depending on the loan to value ratio of the loan. With those kinds of
bribes subsidies, how could DeMarco say no?
Well, DeMarco has. His logic is twofold. First, bag considering the subsidies, they are just a transfer from one pocket (Treasury) to another (Fannie and Freddie) and therefore don’t count as far as the conservatorship mandate of saving taxpayer dollars is concerned. Second, he goes into dueling model mode, and not being able to see his model an d model assumptions, one can’t tell how hard his team has gone in tweaking assumptions to produce the desired result. (if I get my hands on his 18 page letter, which I’ve seen referenced but not posted, I will update the post if it gives more insight on this matter). He concedes in his letter that if you do mods for borrowers that are now delinquent, you see a “small” net benefit (Treasury claimed $1 billion even after the cost of subsidies, it would be telling to see what DeMarco came up with). However, he contends the taxpayer could come up much worse off if people who were current defaulted in order to qualify. His bottom line: “We concluded that the potential benefit was too small and uncertain, relative to the known and unknown costs and risks.”
As much as this blogger is firmly of the view that this is a poor economic decision (deep principal mods are a sound idea, as long as you have a decent approach for vetting borrower income and other debt payments to see if they are viable with a mod), I have to hand it to DeMarco as a bureaucratic infighter. He is effectively throwing the abortion of HAMP results in Treasury’s face. Recall that HAMP did not require borrowers to default in order to qualify for mods, yet many did out of misdirection by servicers. Now in fact, servicers are unlikely to play that game this time, since a principal mod reduces their servicing income. But the fact, as detailed by Neil Barofsky in his book Baiout, that Treasury was indifferent to how homeowners fared under HAMP, and merely saw this as a vehicle for “foaming the runway,” meaning spreading out the number of foreclosures over time, rather than saving borrowers, led to irresponsible actions (like ordering servicers to sign up people for trial mods initially without even qualifying them), numerous changes in program design (disastrous for highly routinized servicers) and lack of concern with the fact that many people lost their homes by virtue of HAMP who might have kept them, has produced some data (in particular, informed estimates of the number of people who defaulted to qualify for HAMP) against the Administration. And notice in its speedy rebuttal letter to DeMarco, Geithner concedes that DeMarco has the power to take this action: “…you have the sole legal authority to make this decision.”
One might wonder why DeMarco is being so intransigent. I am told that he is an old fashioned public servant (as opposed to the tail his opponents are trying to pin on him, that of being a Republican hack), which means he may well believe the strategic default meme (from everything I can tell, this is vastly overblown with primary residences, but is a real phenomenon with second homes. And even with a second home, the damage to one’s credit record alone is a substantial deterrent). What does appear to be different in this crisis is that people who are current on all their obligations will default on their homes. That is interpreted to be a strategic default. But the word from attorneys and mortgage counselors is that these are anticipatory defaults: borrowers who were already under some duress took another reversal, and could see that hitting the wall was now inevitable. Rather than default when they were totally out of money, they default when they still have enough left to at least cover moving costs and a rental deposit.
Needless to say, the Administration stalwarts are up in arms, calling for Obama to fire DeMarco. They might as well yell at the tide. It actually discredits them to rail like this, in that it reveals a failure to do basic homework. First, both the White House and DeMarco have said as the head of an independent agency, he can’t be fired. Second, even if DeMarco were to conveniently disappear, a new appointment would have to be approved by the Senate. Recall what happened with the CFPB. Senate Republicans blocked the nomination of Richard Cordray; Obama had to install him as a recess appointment. Given that Fannie and Freddie are pet demons of the Republican base, not just party stalwarts, the Republicans would more likely to play games to keep the Senate officially in business to stymie a recess appointment than they did with the CFPB (as much as they were not keen re Cordray, he did not merit the sort of pitched battle that an Elizabeth Warren nomination would have elicited).
So what would happen if DeMarco disappeared and there was no new permanent replacement? Another acting director would be chosen from among the four current deputy directors. They have similar views to DeMarco, and I’m told they’d fight Treasury at least as hard as he has.
The way to beat this is not via taking out a contract on DeMarco, it’s in doing a better job of promoting the merits of principal mods and debunking the “deadbeat borrower” meme. But here, the soi disant left has preached to the converted rather than trying to make headway with the broader American public. There is enough distress in the heartlands and enough well warranted antipathy for banks that it ought to be possible to make inroads on this front. But with Obama and Geithner dyed-in-the-wool neoliberals in charge, the failure in messaging comes from the top.
Update 7:00 PM: Adam Levitin points out, per Ezra Klein, that Obama could get rid of DeMarco via simply making a permanent appointment on a recess. Technically true, but Obama had that option to him long ago, in fact back in 2010 when the Senate let his appointee Joseph Smith hang in the breeze and Smith withdrew. And he also could have done it earlier this year, when DeMarco first made his opposition to principal mods clear (he deferred taking a stand as long as possible).
To replace DeMarco at this juncture would be waving a red flag in front of Fannie and Freddie hating Republicans, and would bolster Romney’s campaign by giving them a solid anti-Obama talking point. And the reality, as we indicated above, is that Obama has never been serious about helping homeowners. He’s never crossed swords with the folks who demonize borrowers in distress, never had any of his minions get tough with recalcitrant servicers. He has plenty of latitude to make an impact, and the only thing he threw his weight behind was the cosmetic, bank-serving mortgage settlement. He’s clearly made the calculation, and he has determined he is well served with DeMarco in place as a scapegoat.