The Treasury Department late Friday unveiled a new plan to expand the Home Affordable Modification Program (HAMP) by increasing the incentive fees it pays investors including Fannie Mae and Freddie Mac for agreeing to reduce the principal amount of a mortgage.

Treasury notified the Federal Housing Finance Agency (FHFA) that it will pay principal reduction incentives to Fannie Mae and Freddie Mac “if they allow servicers to forgive principal in conjunction with a HAMP modification,” according to Treasury assistant secretary Timothy Massad.

Treasury is putting pressure on FHFA and its acting director Edward DeMarco who has repeatedly rejected calls for the GSEs to employ principal reductions as a way to help struggling homeowners.

The agency's internal analysis has shown that principal reductions would increase the GSEs' losses and costs to the taxpayers.

But DeMarco has agreed to evaluate the new HAMP principal reduction program in light of the new incentives. Treasury is offering to use billions of dollars of unused HAMP funds to cover 16% to 63% of the cost of a principal reduction on GSE and other loans.

“FHFA's assessment of the investor incentives now being offered will follow its previous analysis, including consideration of the eligible universe, operational costs to implement the changes, and potential borrower incentive effects,” DeMarco said.

Sen. Jack Reed, D-R.I., called the new incentives a “positive step” that should help underwater borrowers, prevent foreclosures and help the housing market. “I expect FHFA to promptly reconsider their analysis and help more Americans avoid foreclosure,” the Senate Banking Committee member said.

In expanding the government's modification program, Treasury also extended the life of the HAMP program by one year through 2013.

As part of the TARP program approved by Congress in 2008, Treasury allocated $50 billion to the HAMP program and it has used less than $10 billion of those funds.

According to BNP Paribas' Anish Lohokare, policy wise, the GSEs have always allowed principal reductions.

But, as was clear from last week's letter from the FHFA to Congress, the FHFA, and particularly Demarco are opposed to principal reduction modifications since they perceive them to be ineffective. Therefore while the policy existed, it wasn't implemented, Lohokare said.

Friday's announcement, according to Lohokare, accomplishes two things. It both increases incentives to servicers to implement the HAMP program and it provides incentives to GSEs to offer principal reductions.

"We would of course  have to see what level of incentives are offered to GSEs," he stated. "But if what GSEs get is similar to a few $1000s that servicers get, that falls well short of severities of 50%-60%, the economics for mods for GSEs would not change materially."

This is a link to Fannie Mae's HAMP guidelines.

FHFA study on principal forgiveness as a loss mitigation tool. 

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