Today we have a guest post by Burbed reader Greg Fielding. This post is reblogged from his site, Bay Area Real Estate Trends, and appears here in its entirety.
Now, I think this passionate piece on the Federal Housing Finance Agency is a great springboard for discussion, but it’s completely irrelevant to what’s going on in the Real Bay Area. Unlike where Greg lives (hint: East is Least), It’s Special Here. We don’t have to worry about underwater mortgages or massive foreclosure meltdown, but maybe some of you know some underprivileged people who don’t live in the RBA.
Anyway, please give Greg a big, warm, RBA welcome! And next time, Greg, don’t hold back. Let everyone know how you really feel.
Dear Edward DeMarco,
Your position regarding principal reduction for underwater mortgages illustrates just how unfit you are to be running the FHFA. You argue against principal reductions, because it might cost “marginally” more than principal forbearance, yet you completely ignore all of the data suggesting that negative equity leads to strategic defaults and a potential death spiral for housing.
Home prices are still falling. Without principal reduction, more and more homeowners will make the financially-prudent decision to walk away. This epidemic can be slowed or even halted with bold action and leadership from people in positions like yours. More of the same simply isn’t going to cut it.
You are an impediment to the recovery of the housing market and our economy. Please submit your resignation, effective immediately, for the good of the Country.
Everyone in the world who is not currently invested in mortgage-backed securities
The head of the FHFA is either corrupt or a fool. Either way he is not the leader we need right now at that position.
The Wall Street Journal reports: DeMarco: Principal Write-Downs Expensive, Benefits Uncertain
Last week, the acting director of the Federal Housing Finance Agency, which regulates Fannie and Freddie, sent lawmakers a detailed analysis of why cutting loan balances doesn’t make sense from a financial standpoint, given the regulator’s mandate to “preserve and conserve” Fannie and Freddie’s assets. […]
Edward DeMarco, acting director of the FHFA, argued that doing so would cause taxpayers to spend more money on the mortgage giants’ rescue than other foreclosure-prevention strategies. Fannie and Freddie have been propped up by taxpayer support for more than three years, a rescue that’s cost taxpayers about $151 billion
“Any money spent on this endeavor would ultimately come from taxpayers and given that our analysis does not indicate a preservation of assets for Fannie Mae and Freddie Mac substantial enough to offset costs, an expenditure of this nature at this time would, in my judgment, require congressional action,” DeMarco wrote in the letter.
About 3 million borrowers with loans backed by Fannie and Freddie owed more on their homes than their properties were worth as of last summer. That’s about 10% of the loans they own or guarantee. A write-down of all 3 million of those mortgages would cost taxpayers $100 billion, Mr. DeMarco estimated.
Fannie and Freddie do offer forbearance plans, in which lenders don’t require any payments on a portion of the loan for up to 12 months. What they don’t offer is forgiveness, where that portion of the loan is wiped out.
Mr. Demarco, in his letter to lawmakers, said FHFA’s analysis concluded that “forbearance achieves marginally lower losses for the taxpayer than forgiveness, although both forgiveness and forbearance reduce the borrower’s payment to the same affordable level.”
DeMarco and the academic-econo-forecasters who put this study together have completely ignored the element of social mood. IF people increasingly feel like there is no hope, they will give up and strategically default. Their study assumes no increase in the total number of foreclosures. It’s as if they are expecting the world to stand still while their economic model runs it’s course in a vacuum.
[...] “Unless there is an expectation that principal forgiveness will reduce losses, we cannot justify the expense of investing in major systems upgrades,” he wrote.
[...] Fannie and Freddie would also risk giving up money if they reduced loan balances because they could no longer recover money from mortgage insurers, which cover some losses for borrowers who have a down payment of less than 20%.
What exactly are the expenses he can’t justify?
Let’s take a look at a chart from his letter. (click for a bigger view)
DeMarco argues that the taxpayers, who are paying for these losses, will save the money outlined above by offering principal forbearance instead of principal reductions. In the four scenarios they outline, these losses range from 5.5% to an actual gain of 1.15%.
Not only are these petty savings to begin with, but the data behind them assume that falling equity will NOT lead to more foreclosures. Even if falling equity only leads to a handful more foreclosures, those additional losses would offset any initial savings. Moreover, down in the trenches, a lot of underwater homeowners are holding out hope for a principal reduction. If they don’t get it, they will rationally stop paying. Edward DeMarco is out of touch with what’s happening at the street-level of the industry he oversees.
Consider Laurie Goodman’s analysis of the situation:
She figures that there will be about 10.4 million more foreclosed homes over the next 5-6 years. She assumes:
- 90% of the existing non-performing loans will eventually end in foreclosure
- 65% of the re-performing loans will end up in foreclosure (these are loans that have been modified).
- 40% of loans with 120% or more LTV will default
- 15% of loans with 100-120% LTV will default
- 5% of loans with less than 100% LTV will eventually default
These numbers are based on performance of similar loans over the last few years. The frightening part is the side-note from the exhibit:
Assumes no change in overall housing prices, interest rates,
or new home construction
So, if 10 million more homes get lost to foreclosure in the coming years, it is reasonable to assume that the that additional distressed inventory would continue to drive home prices even lower. Which, would force adjustments to the 10 million figure, making it even worse.
And so on.
Laurie discusses this “death spiral:”
However, the (housing) overhang means that home prices, despite being very affordable, are likely to decline further. This may recreate the housing death spiral—as lower housing prices mean more borrowers become underwater. We have determined LTV is the single most important predictor of default. So more underwater borrowers means more defaults; more defaults means more inventory, more overhang, and even further declines in home prices. While home prices can go down another 5% without re-igniting this housing death spiral, a 10% decline would certainly re-ignite the spiral in our opinion.
This “death spiral” is the doomsday scenario that Ben Bernanke and crew are doing everything they can to avoid. But Case-Shiller home prices are already declining at a healthy clip – how far away is that “death spiral” really?
Time and time again, policymakers make decisions based on models that can never account for the mood on the street. Or, they know the mood and risks, but are completely corrupt. I’m not sure which camp DeMarco is in, but he is clearly not the leader we need at the FHFA to help get housing back on track.