A federal regulator is blocking the government-owned mortgage giants Fannie Mae and Freddie Mac from reducing the principal that homeowners owe on their mortgages in order to avoid foreclosures.
Tuesday's decision came from Edward DeMarco, the acting director of the Federal Housing Finance Agency.
NPR and ProPublica reported earlier this year that Fannie and Freddie had each determined that reducing principal for struggling borrowers would save money by preventing foreclosures. Despite that, DeMarco said he will not allow debt forgiveness because the risks outweigh the benefits.
Mike Calhoun, head of the nonpartisan Center for Responsible Lending, said, "What makes this especially disappointing is that other lenders are already doing this — it makes good business sense. It saves money for the businesses. In this case it would save money for taxpayers."
Calhoun said nearly half of all loan modifications done for non-Fannie and Freddie loans have a principal reduction component. So he says the private sector thinks it works.
And Calhoun is concerned that the move by DeMarco could make it harder for private banks and other loan servicers to continue what he sees as these very effective types of loan modifications. Some of the language in mortgage-backed securities contracts directs the banks to use "standard servicing practices" and that can be interpreted as following the lead of Fannie and Freddie. But it's unclear how much of an impact DeMarco's decision will have on non-Fannie/Freddie loan modifications.
DeMarco has said that one big concern he has about principal reduction loan modifications is that thousands of homeowners could default on purpose to try to get a handout.
The Associated Press adds:
"About 74,000 to 248,000 homeowners would be eligible for principal reductions from Fannie and Freddie, the [FHFA] analysis showed. An estimated 11 million Americans owe more on their mortgages than their homes are worth.
"The Obama administration immediately voiced its disappointment with the decision.
"'I do not believe it is the best decision for the country,' Treasury Secretary Timothy Geithner said in a letter to DeMarco.
"Geithner said allowing Fannie and Freddie to do 'targeted' reductions of principal for troubled borrowers would provide much-needed help to a significant number of troubled homeowners. He said that would help repair the nation's housing market and result in a net benefit to taxpayers."
Bloomberg News notes that other programs have been implemented to help struggling homeowners.
"Fannie Mae and Freddie Mac have completed 1.1 million loan modifications since the end of 2008, and have engaged in more than 1 million other transactions to avert foreclosures, including short sales or repayment plans."