Rubicon Associates'  Instablog

Rubicon Associates
Send Message
Michael Terry, CFA has nearly 20 years of experience in the investment management industry focused on the analysis, investment and management of fixed income and preferred stock portfolios. Over the years, Mr. Terry has analyzed and invested in both public and private companies around the world... More
My blog:
Follow me on twitter @RubiconAssoc
  • Fannie Mae, Freddic Mac And Principal Reductions 0 comments
    Mar 25, 2012 2:35 PM | about stocks: FNMA, FMCC

    Great article bt Gretchen Morgenson:

    ED DeMARCO is a marked man.

    The acting director of the Federal Housing Finance Agency and overseer of Fannie Mae and Freddie Mac, Mr. DeMarco is a soft-spoken, career public servant - and under fire. In the thankless job of conservator for the loss-ridden mortgage finance giants, he has a duty to ensure that the companies operate in the best interests of the taxpayers who own them. That means working to keep a lid on the companies' losses, which now total $183 billion.

    But in recent weeks, Mr. DeMarco has come under increasing pressure to chuck his obligation to taxpayers and make Fannie and Freddie write down principal on mortgages held by troubled borrowers. He says, with reason, that such a program would run counter to his legal obligation to pursue only those activities that pose the least cost to taxpayers.

    Representative Barney Frank, the Massachusetts Democrat who supported Fannie Mae almost to its collapse, has called for Mr. DeMarco's resignation because he is "too rigid" on the issue. Representative Elijah E. Cummings, a Maryland Democrat and ranking member of the House Committee on Oversight and Government Reform, told a field hearing in Brooklyn last week that Mr. DeMarco "may be the biggest hurdle standing between our nation and the recovery of our housing market."

    Stabilizing the housing market is a noble and desired goal, of course. And legions of borrowers hurt by the bust genuinely need help.

    But what the proponents of principal reductions at Fannie and Freddie don't talk about is what a transfer of wealth from taxpayers (again) to large banks such a program would represent. The fact is, principal reductions by Fannie and Freddie are not the panacea that they may seem.

    As of last September, only 2.5 percent of Fannie and Freddie mortgages were seriously delinquent, versus 7.2 percent for banks' mortgages.

    Still, the crowd clamors for widespread Fannie and Freddie write-downs, even though they would constitute a direct and sizable gift from taxpayers to the largest banks.

    Here's how: Many banks hold second liens on the same properties for which Fannie and Freddie either own the first mortgage or have guaranteed. If principal amounts on these first mortgages are reduced while leaving the second liens intact, those seconds become much more likely to be paid off over time. With no principal reduction, the banks would have to write off many of those second liens.

    As such, principal write-downs are another backdoor bailout for the banks that brought you the mortgage crisis.

    Answering his critics, Mr. DeMarco has agreed to approve principal reductions at Fannie and Freddie, but only when Congress passes legislation enabling it. Writing a law to force taxpayers to bail out the banks in this way, however, might anger constituents. So it's far easier for members of Congress to rail against the one supposedly intransigent man who is preventing the great American housing recovery.

    As the election approaches, of course, the cries are bound to become even more strident.

    In a not-so-funny way, these attacks on Mr. DeMarco are depressingly familiar. Recall happier days when Fannie and Freddie were thriving. Members of their fan club routinely criticized regulators at the Office of Federal Housing Enterprise Oversight who tried to rein in the companies. Those attacks neutralized the regulator and a few lonely critics and are one of the reasons taxpayers are financing $183 billion in losses at the companies today.

    The companies themselves have studied principal write-downs and the effects they would have on taxpayers. But they are inconclusive, according to people who have been briefed on them.

    While some of the same people who helped get us into this housing mess call for Mr. DeMarco's head, it's instructive to see what Fannie and Freddie have done to help troubled homeowners - and to compare, where you can, the companies' efforts with those of banks.

    In the quarter ended last September, Fannie and Freddie were responsible for 36.3 percent of all loan modifications, compared with 19.2 percent by banks. Of the 54,000 loan modifications initiated under the Treasury Department's HAMP program in the September quarter, 44 percent were on Fannie and Freddie mortgages; bank-held loans accounted for a little more than half that share, at 23.6 percent.

    The September quarter is by no means an anomaly. Fannie and Freddie have consistently led in loan modifications since the beginning of 2010.

    Since the companies were taken over by taxpayers in September 2008, they have provided 1.1 million permanent loan modifications for homeowners. This compares with 950,000 permanent loan modifications under the HAMP program done by banks in a slightly shorter period - April 2009 to January 2012. These include modifications on loans held by investors, however.

    There's more. According to a recent report from the Office of the Comptroller of the Currency, loan modifications by Fannie and Freddie have performed far better than those on privately held mortgages. Since the taxpayers took over the companies, re-default rates have been consistently lower at Fannie and Freddie than among privately held mortgages, the report shows.

    This suggests that the types of loan modifications provided by Fannie and Freddie - reducing borrowers' monthly payments - are working fairly well. Addressing borrowers' ability to repay loans has been the focus, Mr. DeMarco said. At the same time, these changes in loan terms do not encourage people to default in spite of being able to pay.

    "What we're doing with the bulk of underwater borrowers is offering loan mods for principal forbearance, taking a good chunk of underwater principal and setting it aside at a zero rate of interest," Mr. DeMarco said in an interview. "We're getting the borrower into a mortgage they have an ability to repay."

    Moreover, most of the borrowers who owe more on their Fannie and Freddie loans than their homes are worth continue to pay their mortgages. The most recent statistics from the companies show that nearly 80 percent of underwater borrowers were current as of June 30 last year. Among those borrowers defined as deeply underwater - their loan-to-value ratios are currently above 115 percent - 74 percent were current.

    Throughout the crisis and its aftermath, banks have been very good at ensuring that others - whether taxpayers, Fannie and Freddie, or private investors who hold loans in mortgage securities - do more to help troubled borrowers than banks have been willing to do themselves. This refusal to share the sacrifice is a major flaw in the recent foreclosure-abuses settlement that regulators have crowed about.

    Last week, The American Banker reported that mortgage securities investors might sue to stop the settlement because these investors object to paying for loan modifications that the banks will receive monetary credit for making.

    So the next time you hear someone advocating vast principal reductions on Fannie and Freddie loans, remind them that it would be another stealth bank bailout, courtesy of taxpayers. Banks' unwillingness to share the pain has been a central feature of this crisis. It's time to put an end to this dysfunctional dynamic.


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Stocks: FNMA, FMCC
Back To Rubicon Associates' Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (0)
Track new comments
Be the first to comment
Full index of posts »
Latest Followers


  • $MSFT buying $LNKD for $26B. Scattershot strategy
    Jun 13, 2016
  • $SSW issues 8.20% series G preferred. $40mm deal. June 2021 call. Pricing on top of Series E
    Jun 9, 2016
  • $NRZ cut to neutral from buy at Compass Point. The 12-month target price is $15.00 per share.
    May 18, 2016
More »

Latest Comments

Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.