HUD Secretary Offers Incentives for Writing Down Mortgages

by 09 Apr 2012 -- Under the terms of the recently approved foreclosure settlement agreement, the Federal Housing Administration (FHA) does not have to reach out to borrowers who are underwater on their mortgages. Reduction of principal mortgage amounts does not apply to borrowers whose home loans are guaranteed by Fannie Mae or Freddie Mac, either.This means that half of all American mortgage borrowers do not qualify to benefit from the settlement.

The Secretary of Housing and Urban Development (HUD) wants to change the mind of Edward DeMarco, Acting Director of the Federal Housing Finance Administration (FHFA) with regard to mortgage modification. HUD Secretary Shaun Donovan spoke to the press about his belief in a program that would ensure the financial stability of Fannie Mae and Freddie Mac. For a financial institution engaged in mortgage lending, writing down loan balances is a risky proposition. The five major banks that signed the foreclosure settlement agreement do not stand to absorb too much damage due to cash reserves and the fact that they were bailed out by the government during the final months of 2008, when the financial global crisis was at a very critical point.

Fannie and Freddie, however, are still being bailed out by taxpayers. Writing down hundreds of thousands of principal mortgage amounts would cost American taxpayers even more and would also endanger the stability of the two mortgage giants. More than half of the borrowers whose mortgages are currently backed by Freddie Mac and Fannie Mae are aware that their principal loan amounts are higher than the value of their homes, thereby placing them underwater. The working definition of underwater mortgages is when the underlying value of the home has dropped by more than 30 percent.

There is one solid argument against the possibility of Fannie and Freddie reducing mortgage loan principals. Borrowers who know they are underwater but continue to make monthly mortgage payments on time may turn to default as a way to qualify for write-downs. Secretary Donovan calls the hypothetical situation explained above a “moral hazard.” In other circles, it is called a strategic default. Donovan added that such hazards can be avoided with the proper checks and balances and financial incentives. The incentives will be offered to DeMarco at the FHFA, but there is not plan B at this time should he turn them down.


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