A column in today’s LA Times makes a compelling case for Fannie Mae and Freddie Mac to rethink their adamant opposition to principal forgiveness. Michael Hiltzak’s analysis also highlights the hypocrisy of the still mysterious Attorneys General settlement.
The dirty little secret is that $17-25 Billion of the AG’s Settlement that is reportedly going to be devoted to principal reduction will actually provide more that $17-25 billion in value to the banks and other lenders. This additional benefit to lenders results because reducing the principal of loans increases the likelihood that those loans will paid. As a result, the Net Present Value of the loans will be increased.
So the bulk of the “heralded” settlement is actually not a cost but a net financial benefit to the scofflaws that the AGs were supposed to be punishing.
Principal forgiveness is actually a win-win proposition for lender and homeowner when a loan is significantly under water.
Hiltzak explains it:
“The reason should be obvious. The most important factor in a borrower’s likelihood of default is the loan’s negative equity. Put simply, if you think you’re so deeply underwater that you won’t have equity in your home by the time you’re ready to sell it, or ever, then default looks more rational the more your ability to pay comes under strain.
The closer you are to breaking even or going positive, the more you’ll fight to keep the house. Forbearance doesn’t get you any closer to that point (you still owe the original principal, one way or another), but forgiveness does.”
Principal forgiveness recaptures the self-interest of the borrower to the benefit of both borrower and lender.
Even the Federal Housing Finance Agency, the agency charged with overseeing Fannie Mae and Freddie Mac told Members of Congress, that principal forgiveness can increase the net present value of underperforming loans.
So, you ask, if its good for lenders and good for borrowers, why isn’t there an effort to rewrite all under water loans in America?
One answer to the question is accountants (no offense to my brother the CPA, well, ok, maybe a little offense intended)
Lenders including Fannie and Freddie are carrying these non-performing loans on their books as if every dime promised is going to be paid. Principal reduction requires that the lenders immediately write down those loans that will effect share prices in the case of the banks and create political risk in the case of the now federally controlled Fannie and Freddie.
The second answer to the question is a little more nefarious, servicers, including all of the big banks that have entered the still undisclosed agreement with Attorneys General charge investors, including Fannie Mae and Freddie Mac significantly higher fees when loans are in default. The percentage of loan proceeds to be paid to servicers increases, plus mortgage loan servicers have become masterful at creating other ways to pay themselves by way of forced place insurance and inspection costs. In foreclosure, the servicers get paid first and if there is not enough from the foreclosure sale, the investor pays the bill.
My hope is that as congress, shareholders and the general public figure this out sooner rather than later.