January 20, 2012
The Honorable Elijah E. Cummings
Ranking Member
Committee on Oversight and Government Reform
2235 Rayburn House Office Building
Washington, DC 20515
Dear Ranking Member Cummings:
In response to your request that the Federal Housing Finance Agency (FHFA) provide the Committee with the specific statutory provision that would prohibit the FHFA from allowing Fannie Mae and Freddie Mac (Enterprises) to reduce mortgage principal in all cases and analysis the agency conducted, including the data examined, demonstrating that principal reduction never serves the long-term interest of the taxpayer when compared to foreclosure, I am providing the following information and attachments.
Prior to a specific response, I would like to apologize for the delay in this response. At no time has there been any lack of respect or indifference to the request and I take full responsibility for the time it has taken to provide this response.
Statutory Requirements
As to statutory requirements, FHFA serves as conservator and regulator of the Enterprises under three principal mandates set forth by Congress that direct FHFA’s activities and decisions. First, FHFA has a statutory responsibility as conservator to preserve and conserve the assets and property of the regulated entities. Second, the Enterprises have the same mission and obligations as they did prior to the conservatorship. Therefore, FHFA must ensure that Fannie Mae and Freddie Mac maintain liquidity in the housing market during this time of economic turbulence. Third, under the Emergency Economic Stabilization Act of 2008 (EESA), FHFA has a statutory responsibility to maximize assistance for homeowners to minimize foreclosures. Under EESA, FHFA must consider the net present value (NPV) of any action undertaken to prevent foreclosures.
These mandates guide every FHFA policy decision, including the decision not to allow Fannie Mae and Freddie Mac to engage in principal forgiveness at this time. FHFA did not conclude that "principal reduction never serves the long-term interest of the taxpayer when compared to foreclosure." In considering principal forgiveness, FHFA compared taxpayer losses from principal forgiveness versus principal forbearance, which is an alternate approach that the Enterprises currently undertake to fulfill their mission at a lower cost to the taxpayer. FHFA based its conclusion that principal forgiveness results in a lower net present value than principal forbearance on an analysis initially prepared in December 2010, which is attached, along with updated analyses produced in June and December 2011, which are also attached.
FHFA Considerations
Putting this determination in context, as of June 30, 2011, the Enterprises had nearly three million first lien mortgages with outstanding balances estimated to be greater than the value of the home, as measured using FHFA’s House Price Index. FHFA estimates that principal forgiveness for all of these mortgages would require funding of almost $100 billion to pay down mortgages to the value of the homes securing them. This would be in addition to the credit losses both Enterprises are currently experiencing.
Another factor to consider is that nearly 80 percent of Enterprise underwater borrowers were current on their mortgages as of June 30, 2011. (Even for more deeply underwater borrowers—those with mark-to-market loan-to-value ratios above 115 percent, 74 percent are current.) This trend contrasts with non-Enterprise loans, where many underwater borrowers are delinquent.
Given that 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.
In considering a program of principal reduction for underwater borrowers, FHFA used the net present value model developed to implement the Home Affordable Modification Program (HAMP). Using the HAMP NPV model for borrowers with mark-to-market loan-to-value (LTV) ratios greater than 115 percent, FHFA compared projected losses to Fannie Mae and Freddie Mac from borrowers receiving principal forbearance modifications to borrowers receiving principal forgiveness modifications as allowed in the HAMP program. The model, and hence the analysis, takes into account the sustainability of the modifications and assumes that principal forgiveness reduces the rates of re-default on the loans to a greater extent than would forbearance. However, in the event of a successful modification, forbearance offers greater cash flows to the investor than forgiveness. The net result of the analysis is 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.
Additionally, there would be associated costs to upgrade technology, provide guidance and training to servicers, and change accounting and tracking systems in order to implement a principal forgiveness program. Unless there is an expectation that principal forgiveness will reduce losses, we cannot justify the expense of investing in major systems upgrades.
Fannie Mae and Freddie Mac already offer a loan modification option that reduces monthly payments to an affordable rate using principal forbearance—the same monthly payment that would be in place with forgiveness—and this is most consistent with FHFA obligations as conservator.
While it is not in the best interests of taxpayers for FHFA to require the Enterprises to offer principal forgiveness to high LTV borrowers, a principal forgiveness strategy might reduce losses for other loan holders. Indeed, in several of the examples cited, such as Ocwen and Wells Fargo, principal forgiveness is being offered to borrowers whose loans the investor or servicer purchased at a discount, which would likely change the analytics significantly. Also, because of Enterprise requirements for credit enhancement of high LTV loans, a high percentage of Enterprise loans have mortgage insurance or second liens. Consequently, a large share of the potential gains from principal forgiveness on Enterprise loans would go to unrelated beneficiaries than may be the case for forgiveness on non-Enterprise loans.
Additionally, less than ten percent of borrowers with Enterprise loans have negative equity in their homes (9.9 percent in June 2011), whereas loans backing private label securities were more than three times more likely to have negative equity (35.5 percent in June 2011).
FHFA remains committed to assisting homeowners to stay in their homes and will continue to update and improve our analysis. FHFA would reconsider its conclusions if other funds become available and if the availability of other funds is at a level that would change the analysis to indicate potential savings to the taxpayers. In addition, other factors to consider in implementing any such policy include whether the borrower had defaulted on a previous loan modification, how much equity the borrower had originally invested in the house and the amount of contribution being made by second lienholders and mortgage insurers.
In the meantime, FHFA continues to focus on improving loss mitigation and foreclosure alternatives through a variety of means. Through HAMP and the Standard Modification that are now available through the Servicing Alignment Initiative, delinquent borrowers or borrowers at risk of default will be reviewed for loan modifications that can include principal forbearance. Borrowers who remain current on their loan payments can take advantage of the recent changes to the Home Affordable Refinance Program (HARP), which now permit all current underwater borrowers to refinance into lower interest rate mortgages.
Please note that the attached document provides the analyses presented to me upon which I have based my decisions. The analyses contain internal FHFA and examination-derived information that would not ordinarily be disclosed. As you will see, our determination has been based on projected economic costs to taxpayers, not short-term accounting considerations. Nor have the analyses been affected by considerations of executive compensation.
If you have additional questions, please contact Peter Brereton, Associate Director for Congressional Affairs, on my staff at (202) 649-3022.
Yours truly,
\\s\\
Edward J. DeMarco
Acting Director
xc: Darrell Issa, Chairman, Committee on Oversight and Government Reform
Attachment
Corinne Russell (202) 649-3032 / Stefanie Johnson (202) 649-3030