To cut or not to cut principal balances, GSE's stuck between a rock and a hard place.
[caption id="attachment_6445" align="alignleft" width="259" caption="Fannie Mae & Freddie Mac to Cut Principal Balances?"]
[/caption] In the wake of the announcement of the $25 billion settlement between state attorney generals and the five major mortgage lending banks in the United States, government-sponsored enterprises Fannie Mae and Freddie Mac have indicated that they are not willing to assist too many homeowners facing foreclosure. Both Fannie Mae and Freddie Mac currently guarantee about half of all mortgage loans in the United States. Borrowers whose loans are guaranteed by Fannie or Freddie will not be able to take advantage of the payouts and loan reductions created by the $25 billion settlement, which is the result of a nationwide investigation into the dubious foreclosure practices conducted by Ally Financial, Bank of America, Citigroup, JP Morgan Chase, and Wells Fargo. Under the terms of the settlement agreement, the banks involved will be required to provide relief to troubled mortgage borrowers. One of the major aspects of the settlement consists of reducing the amount of principal owed for borrowers whose mortgages are underwater, meaning that their loan amounts owed are higher than the value of their homes. Some estimates indicate that 20 percent of all residential mortgages in the U.S. are currently underwater. Fannie and Freddie are not part of the settlement, and they have thus far chosen not to be parties to it. The reason given by officials at both government-controlled mortgage giants is that by writing down home loans
on properties that are facing foreclosure, American taxpayers will end up footing a costly bill. Even though the state attorney generals enlisted the assistance of Shaun Donovan, Secretary of the Department of Housing and Urban Development (HUD), to come up with the settlement agreement, they could not convince Fannie and Freddie to participate. Edward DeMarco, director of the Federal Housing Finance Agency (FHFA), explained that he is opposed to either Fannie or Freddie offering reductions on principal amounts. In the past, Fannie Mae has looked into the matter of principal reductions and determined that they are not effective, considering the cost and work involved. As acting director of the FHFA, DeMarco oversees both Fannie and Freddie, and he thinks that the loan modification programs currently used by the two mortgage companies offer enough assistance to troubled homeowners without resorting to loan write-downs. The Treasury Department recently released figures that indicate principal reductions are more effective than loan modifications that do not write down balances on home loans. Homeowners that do not include principal reductions as part of their loan modification agreements are more likely to default on their modified loans after one year, compared to borrowers who get the benefit of a write-down. [caption id="attachment_6456" align="alignleft" width="282" caption="Freddie and Fannie not budging on Principal reductions"]
[/caption] Several state attorney generals have vowed to continue their fight against the reluctance of Fannie and Freddie to participate in the $25 billion mortgage settlement. Now that President Obama has called for a special financial fraud unit to look into the financial practices of major mortgage lenders in the run-up to the global financial crisis, Fannie and Freddie are expected to be heavily investigated, something that could be used to pressure them into joining the nationwide mortgage settlement.