Political pressure backed with money can be very persuasive in Washington and it may provide relief for some underwater borrowers with Fannie Mae and Freddie Mac loans.

For several months the Federal Housing Finance Agency (FHFA) has been under constant pressure from the Obama administration and Democratic lawmakers to allow the GSEs to offer a principal reduction program. Such an effort would allow servicers to write down a portion of the principal, giving borrowers more of an incentive to stay in their homes.

Until recently FHFA acting director Edward DeMarco insisted such write downs would increase Fannie/Freddie losses, and as the GSE conservator, he could not justify passing the cost onto taxpayers.  But that objection melted away once Treasury Department upped the incentive payments it pays to Home Affordable Modification Program servicers that actually agree to principal reductions.

In a speech last week, DeMacro conceded that the higher incentive payments make principal reductions cost effective for Fannie and Freddie. Analyzing a pool of 700,000 delinquent loans, FHFA officials estimate principal reduction modifications -- compared to principal forbearance -- would reduce GSE losses by $1.7 billion.

But DeMarco did not signal any intent to start a principal reduction right away.   

The economist and career civil servant remains concerned principal reductions targeted on delinquent borrowers will create an incentive for other GSE borrowers to default. There are 2 million underwater borrowers with Fannie/Freddie loans that are current on their mortgages.

"Encouraging their continued success could have a greater impact on the ultimate recovery of housing markets and cost to the taxpayers than the debate over which modification approach offered to troubled borrowers is preferable," DeMarco told an audience at the Brookings Institution in Washington.

In considering whether the GSE should forgive principal, DeMarco said the agency will have to analyze the effects on current borrowers and operational costs.  He plans to make a decision in a few weeks.

Keefe Bruyette & Woods senior vice president Brian Gardner expects FHFA will go forward with a “modest” principal reduction program for severely underwater borrowers. “He left the door open and the political pressure is pushing him to do more,” the KBW Washington analyst said.

Thirty Democratic senators recently sent the GSE regulator a letter urging him to adopt a targeted principal reduction program.  The senators asked FHFA to conduct an analysis where a reduction is offered to certain underwater homeowners – such as delinquent borrowers who don’t have mortgage insurance.

Republican senators have supported DeMarco’s resistance to principal reductions. The American Bankers Association also is concerned a full-scale principal reduction campaign will increase strategic defaults and undermine the housing finance system.

“A broad principal reduction program would result in fewer investors who are willing to lend for housing finance, increase borrowing costs, and make credit tighter,” said ABA president and chief executive Frank Keating.  

A recent Comptroller of the Currency report shows eight national banks employed principal reductions in modifying portfolio loans and investor loans during the fourth quarter. 

"OCC has long held the position that principal reduction can be an effective tool in the arsenal for loss mitigation," an OCC official said. Meanwhile, HAMP servicers completed 22,260 loan modifications in February and 20% of the modifications involved a reduction in the principal amount of the loans. The median principal amount reduced is $68,500. 

Starting in March, Treasury tripled its incentive fees and now it pays up to 63% of the costs of a principal reduction.

Treasury rolled out the HAMP principal reduction program in October 2010.

Since then, Bank of America and Wells Fargo Bank have approved at least 12,000 principal reduction modifications. 

JPMorgan Chase has approved nearly 10,900 reduction mods and Ocwen Loan Servicing has approved 8,800.  OneWest Bank is a distant fifth in the rankings with 2,700 principal reduction mods.

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.

30-Day Free Trial

No credit card required. Access coverage of the securitization marketplace, including breaking news updated throughout the day.