Transcript: FHFA Director Edward DeMarco on mortgage principal forgiveness
Transcript of remarks by Federal Housing Finance Agency Acting Director Edward DeMarco on whether Fannie Mae and Freddie Mac should offer loan principal forgiveness for underwater mortgage borrowers (April 10, 2012):
“Over the past six years, many efforts have been launched by the federal government to stem the losses arising from the housing crisis and to keep people in their homes.
“Some programs have worked better than others. But almost all of them required trial and error and were more difficult to actually implement than many people had expected.
“As conservator of Fannie Mae and Freddie Mac, the Federal Housing Finance Agency has been deeply involved in many of these efforts, and we have seen our share of success and missteps.
“Today, we find ourselves in the midst of a national debate regarding mortgage principal forgiveness.
“Would homeowners, the housing market, and the taxpayer be best served by providing outright forgiveness of mortgage debt for certain homeowners who currently owe more on their mortgage than their house is worth today?
“I’m grateful to the Brookings Institution for this opportunity to offer some perspectives on this debate and to provide some preliminary findings from FHFA’s most recent analysis of this issue.
“I will not be announcing any conclusions today. Our work is not yet complete.
“But in view of the state of the public policy debate on this subject, I am pleased to have this venue to enhance the public’s understanding of this difficult question and to explain how FHFA has approached the matter.
“The Brookings Institution’s reputation as a home for thoughtful policy, analysis, and debate of challenging public policy questions makes this a most appropriate setting for this endeavor.
“Typically, when I begin a speech about Fannie Mae and Freddie Mac or “the enterprises” as I will refer to them, I set the context by reviewing FHFA’s legal responsibility as conservator. I do so because I believe it is essential for people to understand that Congress considered the objectives it wanted FHFA to pursue as conservator. These objectives may not be easy to meet, but they are clear. FHFA’s job is to preserve and conserve the assets of the enterprises, and in their current state, that translates directly to minimizing taxpayer losses. We are also charged with ensuring stability and liquidity in housing finance and maximizing assistance to homeowners.
“Today, however, I want to set the context for my remarks in a different way. I’d like to begin with a few words on the human element of this housing crisis.
“Throughout this crisis, each of us know of or have heard about many individual stories of homes lost through foreclosure. One cannot help but have sympathy for those who have suffered such misfortune. And surely, no one can look at the dislocations in the housing market and not feel frustration at how so many people and institutions failed us whether through incompetence, indifference, or outright greed or fraud.
“Yet, we’re also blessed in this country with people and institutions who care, who are strongly motivated to provide assistance and find solutions.
“The staff at FHFA has worked tirelessly since the enterprises were placed into conservatorship to seek meaningful, effective responses to the housing crisis.
“With the staffs at Fannie Mae and Freddie Mac, at the Treasury Department and HUD, and numerous financial service companies, FHFA has sought to develop and improve on loan modifications and loan refinance programs that bring meaningful options to struggling homeowners who want to stay in their homes.
“In a moment, I will describe these efforts and their progress to date. We know we have much more to do in this area and the strategic plan for conservatorship that we submitted to Congress in February identifies that work as one of our three strategic goals.
“There’s another human element in this story that does not seem to receive much attention. Clearly, many households got overextended financially. Some accumulated debts they couldn’t afford when hours or wages were cut or jobs were lost. Others withdrew equity from their homes as house prices soared. Others bought houses at the peak of the market, often with little money down, perhaps in the belief that house prices would continue to climb.
“Yet, there are other Americans that did not do these things. There are families that did not move up to that larger house because they weren’t comfortable taking the risk. Perhaps they had to save for college or retirement and did not want to invest that much in housing.
“And there are people working multiple jobs or cutting back on the family budget in many ways to continue making their mortgage payments through these tough times. Many of these families are themselves underwater on their mortgage even though they may have made a sizable down payment.
“Whichever of these categories any of the particular homeowners fall into, the decline in house prices over the last few years has reduced the housing wealth of all homeowners.
“Federal Reserve has estimated that from the end of 2005 through the end of last year, the decline in housing wealth amounts to some $7 trillion.
“Six years into this housing downturn, the losses persist. The debate continues about how we as a society are going to allocate the losses that remain.
“Asking hard questions in this debate does not make one unfeeling about the personal plight this situation has created for so many.
“Indeed, the majority of those most hurt by this housing crisis did nothing wrong. They were playing by the rules but they’ve been the victims of timing or circumstance or poor judgment.
“In short, the human element in this unfortunate episode in our country’s economic history stands out and command our attention. Virtually every homeowner in the country has suffered a loss. But that doesn’t make the answers any easier. And it poses a deep responsibility on policymakers to weigh all these factors in seeking solutions, including the long-term impact on mortgage rates and credit availability of the actions we make take today.
“With this backdrop, my goal today is to answer two questions:
“What do the enterprises do to assist borrowers through these troubled times in housing?
“And how has FHFA assessed principal forgiveness as an option for assisting troubled borrowers?
“So let’s begin with borrowers assistance efforts.
“Some critics have concluded that FHFA’s refusal to allow principal forgiveness raises questions as to the agency’s and the enterprises’ commitment to helping borrowers stay in their home.
“To put the principal forgiveness discussion in context, I think it is useful to start by reviewing the enterprises’ current borrower assistance programs.
“Fannie Mae and Freddie Mac have an array of foreclosure prevention programs for borrowers that are delinquent or in imminent default, most of which allow the troubled borrower to stay in their home. For those who are current on their mortgage, refinance opportunities allow borrowers to lower their monthly payment or shorten the term of their mortgage. The primary focus of the enterprises’ foreclosure prevention programs is on providing borrowers the opportunity to obtain an affordable mortgage payment for borrowers who have the ability and the willingness to make a monthly mortgage payment.
“Let’s look more closely at foreclosure prevention efforts. I’ll start with home retention options of which loan modification is the principal approach.
“The enterprises’ current loan modification programs are designed to help homeowners who are in default and those who are at imminent risk of default.
“Now, let me say we’re going to be posting on our website a lengthier version of the remarks that I will be making this morning, and they go into greater details about this and some of the figures and tables that I will be using in this presentation. So I will try to summarize some of this as we go along.
“What this chart shows is that for troubled borrower seeking a loan modification, the mortgage servicer will first work through with the borrower what they are eligible for and what they can benefit from at HAMP or Home Affordable Modification Program modification. All right? And this chart shows the order of the steps taken to reduce the borrower’s monthly mortgage payment down to 31% of their current gross monthly income.
“Some borrowers aren’t eligible for or can’t benefit from a HAMP mod and Fannie and Freddie have their own proprietary modifications – or standard mod – that they also offer.
“And so the second column works through that modification approach as well. But again, the idea here is the borrower is bringing an affordable monthly payment.
“You will note in these two columns that they both talk about forbearing on the principal.
“With a principal forbearance modification, a portion of the loan principal amount is set aside – usually the underwater portion. The homeowner does not pay interest on that portion of the loan.
“This means that the lender allows the homeowner to defer payment on a portion of their principal until they sell the home or later refinance their home, and during this period of deferral, they are paying no interest.
“This approach allows the enterprises to reduce the borrower’s monthly payment while avoiding an actual principal write-off.
“Interestingly, this is the same approach used in many government-guaranteed loan programs including the FHA program.
“Enterprises also offer temporary assistance because a loan modification is not always the best solution. For someone who loses their job, has a medical emergency or faces some other short-term issue, a loan mod is not necessarily best. In such cases, Fannie and Freddie offer payment forbearance plans that allow a borrower to make no or only partial payments for a period of time. The enterprises also offer repayment plans for borrowers who fall temporarily behind and just need an opportunity to get caught up and back on track.
“Since the start of the conservatorship in late 2008, Fannie and Freddie have entered into more than 660,000 such plans.
“As the slide shows, there are also non-retention options. Most troubled borrowers should qualify for a home retention option if they have the ability and the desire to stay in their homes.
“But if the borrower does not want to remain in their home or has experienced a permanent and significant loss of income that makes continued homeownership infeasible, the servicer is obligated to consider the borrower for a short-term, a deed-in-lieu or a deed-for-lease. Of these, short sales are the most common. In a short sale, an enterprise agrees to allow the borrower to sell the home in an arm’s length transaction and accept the proceeds as payment of the debt. Importantly, the unpaid balance becomes forgiven principal to the borrower. Fannie and Freddie have completed more than 300,000 of such home forfeiture actions since conservatorship.
“So in short, Fannie and Freddie’s instructions to mortgage servicers are clear. Only after all these home retention and home forfeiture options have been exhausted should the servicer pursue foreclosure.
“So, let’s turn to the results.
“While mortgages owned by other financial institutions are held in private-label mortgage-backed securities have a much higher delinquency rate than those owned or guaranteed by the enterprises, the enterprises have been leading national foreclosure prevention efforts.
“Fannie Mae and Freddie Mac own or guarantee 60% of the mortgages outstanding but they account for only 29% of seriously delinquent loans.
“Even thought these other market participants then are holding 71% of seriously delinquent loans, Fannie and Freddie account for more than half of all HAMP permanent modifications.
“Between HAMP and their own proprietary loan mods, the enterprises have completed 1.1 million loan modifications since entering conservatorship.
“Not only are the enterprises leading efforts in completing loan modifications, the performance of these modifications has been better than that of other market participants and, I would add, probably better than what most analysts have expected.
“This chart here shows various stages after modification what the re-default rate on the loan modifications have been.
“While there are many issues involved in the decision on whether the enterprises should employ principal reduction that I will discuss later, data on loan modifications from the enterprises shows that performance on loan mods is not strongly related to current LTV [loan to value].
“All right? So take a look at this slide.
“While not a definitive analysis, if current LTV – loan to value – had a strong effect, we would expect that the more underwater the borrower is, the higher the re-default rate would be. However, Fannie Mae data that we present in this slide shows that performance on modified loan does not vary much at all across the loan to value ratio.
“So as you can see in this chart, looking at the current loan to value ratio, at the time to modification even for those deeply, deeply underwater, the re-performance rates on these loan mods have been about the same.
“So what this tells us is that what matters most here is that the performance on loan modifications seems to be more of a function of the payment change to the borrower rather than the loan to value. And this slide is showing indeed the greater the payment decrease that the borrower gets, the greater the re-performance rate on the modification.
“Collectively, these efforts have made a meaningful impact on reducing foreclosures. Since conservatorship, the enterprises have completed more loan modifications than foreclosures and adding all other foreclosure prevention actions to the loan mods totals to some 2.1 million foreclosure prevention actions that the enterprises have taken, which is more than twice the number of foreclosures they’ve completed during this same period.
“Enterprises also offer borrower assistance for those who are current on their loans. Working with the Treasury Department and the enterprises, FHFA developed a Home Affordable Refinance Program. Exclusive to enterprise-owned mortgages, HARP allows underwater and near-underwater borrowers a path to refinance their mortgage without obtaining new mortgage insurance or some other credit enhancement as would normally be required.
“Since April of 2009, the enterprises have acquired 10 million refinanced mortgages of which more than 1 million were HARP loans. Still, these HARP results fell short of what we believed we could achieve. Consequently, FHFA engaged with Fannie and Freddie, the Treasury Department and a wide array of market participants to identify and resolve impediments to the program. Changes we made to the program took effect last December and already many of the largest lenders in the country are seeing tremendous homeowner interests in this revised HARP program. And we expect the volume of HARP loans to be increasing in the near future.
“Let me turn now to principal forgiveness.
“In the original HAMP program, principal forgiveness was always permitted but was rarely used.
“In 2010, to encourage greater use of principal forgiveness, for loans with loans to value ratios above 115%, Treasury supplemented the original HAMP program with the HAMP principal reduction alternative or the HAMP PRA.
“HAMP PRA is an investor option – not a borrower option – and the HAMP program does not require the lender to offer principal reduction even if the servicer determines it to be superior to the standard HAMP mod on a net present value basis or NPV basis.
“The take up rate on HAMP PRA has been low. And earlier this year, Treasury announced its intention to triple its current incentive payments to investors who use this approach.
“While both the original HAMP and HAMP PRA focus on a borrower’s ability to pay by reducing the monthly mortgage payment to 31% of the borrower’s monthly income, PRA also addresses a borrower’s willingness to pay by reducing the loan balance.
“The rationale for the reduction in loan balance is that a borrower whose mortgage exceeds the home’s value may not be willing to continue to make monthly mortgage payments. In other words, even though the borrower may achieve an affordable monthly payment – the ability to pay – through a basic HAMP mod, the borrower may not continue to have the willingness to pay because they’re deeply underwater.
“By forgiving principal as part of the HAMP modification, the lower the loan value ratio should improve the borrower’s willingness to pay. In fact, historical data has shown that the probability of default correlates with the borrower’s current loan to value ratio. The higher that ratio, the greater the likelihood of default. So, by reducing principal and reducing a borrower’s current LTV ratio, the probability of default is reduced and, hence, losses are reduced.
“This type of relationship between default and current LTV, supported by previous analytic work, in fact is embedded in the HAMP net present value model and, thus, has been explicitly factored into FHFA’s repeated analyses of principal forgiveness.
“Now, some proponents of principal forgiveness would limit eligibility in various ways, such as precluding it for cash-out refinance loans or loans that have mortgage insurance. There’s no consensus on what such limits should be nor does the HAMP PRA option impose any beyond the basic HAMP eligibility requirements.
“However Fannie and Freddie might apply principal forgiveness, it would have to be clear and transparent, having a basis in the conservatorship mandate and a general acceptance of reasonableness, if not fairness. And it would have to be clearly and publicly described so that more than 1,000 mortgage servicers could apply these rules the same way.
“So let me look first at our previous analysis of principal forgiveness. At the most basic level, the comparison between the loss mitigation strategies of principal forbearance and principal forgiveness is related to who gets the upside.
“For both principal forbearance and principal forgiveness, if a borrower defaults, enterprises lose the same amount.
“However, if a borrower performs successfully on a modification in a principal forbearance mod, the enterprise retains an upside to the forborne amount. But in a principal forgiveness modification, the borrower retains the upside. And so that’s what this figure tells us here – that the borrower re-defaults after the mod, the losses theirs either way.
“If the borrower defaults sometimes later but there’s been some payment down on principal and house price appreciation, then the investors loss through forbearance could be less than it is through forgiveness.
“But if the borrower is successful as a result of this modification – remains current, stays in the home for a while, house prices recover – there’s an opportunity for the taxpayer to be repaid that entire principal amount if forbearance is used. But in the case of principal forgiveness, the amount that was forgiven upfront remains a loss.
“Now, this basic relationship between principal forbearance and principal forgiveness largely explains the results in analyses that FHFA provided to Rep. [Elijah] Cummings in January.
“Before more fully describing the earlier analysis, one key point is worth reiterating. Any analysis of employing principal forgiveness involves more than just looking at NPV results. At a minimum, FHFA would have to consider the operational costs of implementing the program and the borrower incentive effects from the program given that three-quarters of enterprises’ deeply underwater borrowers today are still current on their mortgage.
“In the analysis we published in January, we did not go beyond the NPV analysis as the results did not indicate that principal forgiveness would produce superior results to principal forbearance.
“So now let’s turn to the latest change to the HAMP program – the triple HAMP payment incentives.
“FHFA is still in the process of analyzing whether the enterprises will offer principal forgiveness as part of HAMP with the triple incentives provided by Treasury.
“This morning, I will provide some preliminary findings from refreshing our earlier analysis incorporating the triple incentives and altering our model work based on the critiques that our previous works have received.
“As I noted earlier, in considering principal forgiveness as a loss mitigation tool, besides the NPV impact we also will need to consider operational costs and borrower incentive effects.
“Now, questions were raised about the methodology that FHFA employed in its earlier analyses.
“To address these concerns, we’ve made the following adjustments.
“We’ve lowered delinquent borrower’s FICO scores or credit scores by 100 points to better reflect the current credit standing of the borrower rather than where they were at the time the loan was originated.
“We’ve raised delinquent borrower’s housing payment debt to income ratios. Those below 45% have been set at 45% and those above 45% have not been adjusted.
“This time around we’ve applied zip code level rather than state level house price indexes to estimate what the current loan to value ratio of the mortgages.
“Rather than doing the analysis as simply forbearance-only versus forgiveness-only, this time around we used the original – we used the full HAMP PRA and regular HAMP waterfalls to work through what the actual payment to the borrower would be. And again, we’ve incorporated the triple incentive payments that would come to Fannie and Freddie from doing principal reduction.
“In addition, the original analysis that we produced considered all enterprise loans that had a current loan value above 115% not just the delinquent borrowers. This time, to provide an estimate of potential the HAMP borrower pool, the analysis I’m going to talk about here limits the analysis to those borrowers that are deeply underwater – so above 115% loan to value and are delinquent on their mortgage today.
“We did allow for some portion of those who are still current today to roll into delinquency. So what we did is we assumed 5% of the enterprises’ deeply underwater borrowers who are current on their mortgage – we assume that 5% of them will roll into becoming delinquent and then, hence, being considered for a loan mod. This wasn’t randomly decided. The 5% is actually the roll rate we saw from the end of December 2010 to the middle of 2011.
“So let’s look at some of the results here. This slide shows that the enterprise losses on these loans are expected to be almost $64 billion if they are not modified but went through foreclosure. So you can see in the two columns the $63.7 billion there.
“Now, if we do principal forbearance, the model results tell us that the losses on these loans would be $55.5 billion.
“If we use the HAMP principal reduction alternative, the losses would be $53.7 billion to Fannie and Freddie.
“Hence, in this analysis, principal reduction is better for the enterprises. That is it reduces the enterprises’ losses by $1.7 billion.
“Now, the total potential incentive payments from the Treasury to the enterprises in this analysis would be $9.5 billion. But the expected incentive payments that would actually be paid is much less. It would be $3.8 billion. That’s the bottom of the last column here. And the reason for this difference is that the HAMP model allows for and predicts that a good number of the borrowers who get this loan modification are still going to default anyway. And if they default anyway, not all of these incentive payments would actually get paid because the incentive payments from Treasury are paid out over several years.
“So in summary, on just a net present value basis, this updated analysis shows a positive benefit to the enterprises of $1.7 billion and Treasury’s incentive payments to the enterprises of $3.8 billion, which would imply a net cost to the taxpayer of $2.1 billion. Now, this does not account for any of the offsetting benefits in terms of greater housing market stability if principal reduction reduces total foreclosures relative to doing a standard HAMP mod but that benefit is difficult to quantify.
“As I’ve noted the NPV results alone are not the sole basis for the decision on whether the enterprises should pursue principal forgiveness.
“One factor that needs to be considered is the borrower incentive effects. That means will some percentage of borrowers who today are deeply underwater but current on their mortgage be encouraged to either claim a hardship or actually go delinquent in an attempt to capture the benefits of principal forgiveness. This is a particular concern for the enterprises because unlike other mortgage participants that can pick and choose where principal forgiveness makes sense, the enterprises must develop a program to be implemented the same way by more than 1,000 seller-servicers. In addition, the enterprises will have to publicly announce this program and borrower awareness of the possibility of receiving a principal reduction modification will be heightened among enterprise borrowers. So as opposed to more targeted efforts of individual lenders or the current opacity of the HAMP process, there is a greater possibility that the borrower incentive effects would take place on an enterprise-wide principal forgiveness program.
“Now it’s difficult to model these borrower incentive effects with any precision. What we can do is give a sense as to how many current borrowers have to be successful become strategic modifiers for this MPV economic benefit provided by the Treasury incentives to be eliminated.
“In this context, a strategic modifier would be a borrower that either claims a financial hardship or misses two consecutive mortgage payments in an attempt to qualify for HAMP to qualify for principal forgiveness.
“This table provides some sense of the results. If principal reduction was successfully done on all 691,000 borrowers that I talked about a few slides ago, the enterprises would have to need 90,000 additional borrowers strategically modify for that to wipe out the benefit to them of receiving the Treasury incentive payments. But that’s unlikely right? Because we’re not going to get 100% pull-through on loan mods offering principal forgiveness.
“Suppose we were successful on half of this 691,000, then we would need roughly 50,000 strategic modifiers. And if we have only a quarter pull through principal forgiveness, then we would need only 20,000 current borrowers to strategically modify in order to wipe out the benefit to enterprises of the incentive payments.
“And keep in mind in this that the enterprises have about 2 million deeply underwater borrowers today who are current on their loan.
“Finally, in considering whether the enterprises should adopt principal forgiveness under HAMP, FHFA must also consider operational costs. The direct operational costs would focus primarily on technology modifications and improvements. We’re still evaluating those costs but they’re not trivial.
“There will be other more indirect costs. These include the costs of launching a new program including the development of guidance to and training for mortgage servicers.
“The indirect costs also include the opportunity costs of diverting existing resources at Fannie and Freddie from other loss mitigation activities or from some of the activities announced in the Strategic Plan.
“All these cost factors would have to be carefully considered in coming to a decision to employ principal forgiveness or not.
“In closing, let me try to summarize all of this into a handful of conclusions and observations.
“The issue before us is not about whether Fannie Mae and Freddie Mac provides support to families having trouble making their mortgage payments. Clearly, they already do, and it remains FHFA’s and the enterprises’ collective objective to do so.
“As FHFA makes its decision on whether the enterprises should offer principal forgiveness with the HAMP triple incentives, we will look to the issues I’ve described – the net present value impacts, the borrower incentive effects, and the operational costs. Those are the issues within our responsibility as conservator of the enterprises.
“Whether Fannie Mae and Freddie Mac forgive principals or not, the universe of enterprise borrowers potentially eligible for a HAMP principal reduction is well less than a million households or a fraction of the estimated 11 million underwater borrowers in the country today.
“This is not about some huge difference-making program that will rescue the housing market. It is a debate about which tools at the margin better balance two goals – maximizing assistance to several hundred thousand homeowners while minimizing further costs to all other homeowners and taxpayers.
“The anticipated benefit of principal forgiveness is that by reducing foreclosures relative to other modification types, enterprise losses would lowered and house prices would stabilize faster, thereby producing broader benefits to all market participants.
“The far larger group of underwater borrowers who today have remained faithful to paying their mortgage obligations are the much greater contingent risk to housing markets and to taxpayers. Encouraging their continued success could have a greater impact on the ultimate recovery of housing markets and costs to the taxpayers than the debate over which modification approach offered to troubled borrowers is preferable.
“A key risk of principal forgiveness targeted to delinquent borrowers is the incentive created for some portions of the current borrower population to cease paying in search of a principal forgiveness modification.
“In closing, the population of underwater borrowers current and delinquent remains a key risk for Fannie and Freddie, for taxpayers, and for the housing market.
“There may still be improvements to current efforts that can mitigate this risk in a cost effective way.
“I want to conclude by saying that FHFA is committed to working with the administration and with Congress on these difficult questions because we recognize that we all have a shared objective of preventing avoidable foreclosures, minimizing taxpayer losses, and bringing a greater measure of stability to housing markets across the country.”
- Federal Housing Finance Agency: Addressing the weak housing market (PDF)
- C-SPAN.org: Video of Edward DeMarco’s remarks at the Brookings Institution’s panel on the weak housing market (April 10, 2012)
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