The Treasury Department is fighting back against critics of principal reduction who claim second lien holders will unfairly benefit from a reduction in the loan balances of underwater Fannie Mae/ Freddie Mac loans.
A web posting by Michael Stegman, a housing advisor to Treasury secretary Tim Geithner, points out that the Home Affordable Modification Program (HAMP) is designed to ensure the second lien holder does not benefit at the expensive of the first lien holder.
The HAMP program pays incentive fees for principal reductions. But it also requires the servicer to reduce the principal on a second lien by a proportional amount.
"So quite contrary to providing a windfall for banks, GSE participation in this program would force them to help homeowners even further by writing down these second lien loans," Stegman says in a Treasury Note dated April 2.
The GSE regulator is evaluating whether Fannie and Freddie should participate in the HAMP principal reduction program for the first time.
Keefe, Bruyette & Woods analysts contend GSE participation would increase the number of modifications that stay current without increasing the number of strategic defaults.
If the Federal Housing Finance Agency gives the GSEs the green light, "We believe the potential principal reductions would just be for delinquent loans" through the HAMP program, the KBW analysts write in a new report. "It is possible the program is even narrower and limited to delinquent borrowers who are severely underwater (over 125%)."