DeMarco Outlines Justification against GSE Principal Reduction

Acting Federal Housing Finance Agency (FHFA)
Director Edward J. DeMarco responded Friday to a request from 16 House
Democrats to explain the statutory authority that DeMarco has claimed prohibits
FHFA from offering principal reduction as part of loan modifications on loans
it owns or guarantees.  The request was
made last November after DeMarco told the House Committee on Oversight and
Government Reform that his agency had concluded that “the use of principal reduction within the context of a loan
modification is not going to be the least-cost approach for the taxpayer.”  When a committee member pointed out that several
banks are already implementing principal reduction programs in an attempt to
help delinquent or underwater homeowners and citing specific examples, DeMarco said “I believe that the decisions that we’ve made with regard
to principal forgiveness are consistent with our statutory mandate,” and committed
to providing documentation of that statutory authority to the Committee.

In
a letter sent to the Committee’s ranking member Elijah Cummings (D-MD) DeMarco laid
out the statutory requirements as originating in three congressional mandates;
first FHFA’s role as conservator and regulator of the government sponsored
enterprises (GSEs) which requires it to preserve and conserve the assets and
properties of the GSEs; second, maintaining the GSE’s pre-conservatorship missions
and obligations to maintain liquidity in the housing market; and third, under
the Emergency Economic  Stabilization Act
of 2008 (EESA), FHFAs statutory responsibility to maximize assistance to
homeowners to minimize foreclosure while considering the net present value
(NPV) of any action to prevent foreclosures.

The focus of the letter, however, is not
the statutory framework but rather why FHFA has decided that principal
forgiveness does not meet its core responsibility within that framework to
preserve and conserve the assets of the GSEs.

DeMarco’s rationale relies on an internal
analysis provided to him in December 2010 and updated in June 2011 which shows
that the use of principal reduction as a loss mitigation measure for GSE loans
under with the Making Home Affordable (HAMP) program or the FHA Short Refi
program would cost the Enterprises more than the benefits derived and
recommended that, instead the GSEs should more aggressively pursue propriety
loan modifications
that reduce the interest rate, extend the mortgage term, and
provide for substantial principal forbearance and promote HARP refinance
transactions for borrowers who are current on their mortgages but underwater in
respect to their equity. 

The GSEs collectively guarantee or hold
about 30 million loans and, using the FHFA Home Price Index to estimate home
values it appears that less than two million of these loans are secured by
properties valued at less than the outstanding debt; i.e. underwater.  Of these loans, more than half are performing
and about one-half million are severely delinquent or in foreclosure.  The table below clearly shows that high LTV
loans are only a small proportion of the GSE’s loans and that most of the loans
are either current or severely delinquent.

Using the Treasury HAMP NPV model the
FHFA study team compared the economic effectiveness of forgiving principal down
to a mark-to-market LTV (MTMLTV) level of 115 percent versus forbearance of the
same amount of principal for all loans with a MTMLTV greater than 115 percent.  The model suggested no better result from principal
reduction than from forbearance and showed the latter as slightly more
effective in reducing GSE losses.  The
team also evaluated the accounting and operational implications of the
principal reduction to measure those costs against benefits to borrowers.  The costs were found to include, in addition
to the immediate losses, the costs of modifying technology, providing training
to servicers, and the opportunity cost of diverting attention away from other
loss mitigation activities.

Principal forbearance, in
contrast, requires no systems changes and is a common approach in government
credit programs, including FHA. The borrower is offered changes to the loan
term and rate as well as a deferral of principal, which has the same effect on
the borrower’s monthly payment as principal reduction, but provides the investor
with potential recovery. The forborne principal is paid in full or part upon
sale of the property or payoff of the loan. This traditional approach would
minimize the Enterprise losses and treat GSE borrowers in a manner that is
consistent with other government programs.

Given the large portion of the
high LTV borrowers that are current on their mortgages, a principal reduction
program for this segment, such as the FHA Short Refi program, simply transfers
performing GSE borrowers over to FHA, at a cost to the GSEs. A less costly
approach for the Enterprises to assist these borrowers is to provide a GSE
refinance alternative, such as HARP. Clearly, the HARP program has been
underutilized to date, suggesting that the program features should be revisited
to remove barriers to entry wherever possible.

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FHFA Veteran Picked to Run Strategic Plan for Fannie and Freddie

The Federal Housing Finance Agency (FHFA) announced a new office to implement its Strategic Plan for Fannie Mae and Freddie Mac Conservatorships and named the person who will head it.  Acting FHFA Director Edward J. DeMarco appointed Wanda I. DeLeo as Deputy Director of FHFA, responsible for the newly created Office of Strategic Initiatives.

The Plan which was sent to Congress is February established objectives and steps for FHFA to take to meet its obligations as conservator of the two government sponsored enterprises (GSEs).  Under the plan, the next phase of the conservatorship will require FHFA to:

  • Build a new infrastructure for the secondary mortgage market;
  • Contract in a gradually manner the GSEs dominant presence in the marketplace while simplifying and shrinking their operations; and
  • Maintain foreclosure prevention activities and credit availability for new and refinanced mortgages.

DeLeo is moving into her new role from one as Deputy Director of the FHFA’s Division of Examination Programs and Support and has held other positions at the agency including as its Chief Accountant.  She will be the central point of contact for all matters related to the Strategic Plan with an immediate task to identify and organize key stakeholders, work streams and deliverables that flow from the plan.

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Donovan: Refinancing Proposals Would Benefit Economy, Borrowers, and Taxpayers

In a press briefing held in advance of President Obama’s appearance in Reno, Nevada, Housing and Urban Development (HUD) Secretary Shawn Donovan gave a preview of the home refinancing aspects of the President’s “To Do List” for Congress which he will be discussing further this afternoon.  Donovan also provided updates on the results of last fall’s executive refinancing initiatives.

Donovan said that last October,  the President had included proposals to increase refinancing in the jobs plan he submitted to Congress.  Ordinarily, the Secretary said, the economy would be receiving an enormous boost from the record low interest rates so refinancing is a critical step in realizing this.  When Congress did not act on the jobs bill the President asked administration officials to identify what could be done without Congressional action to remove barrier to refinancing.  Within six weeks, Donovan said, five barriers were identified and the administration moved to remove or mitigate them.

The result has been a 50 percent increase in refinancing applications, roughly one in three of which is for a HARP loan, up from one in ten a year ago.  The increase has been even greater in areas hardest hit by price declines and foreclosures.  According to data from the Mortgage Bankers Association, refinancing applications are up 240 percent in Nevada, 180 percent in Arizona, and 125 percent in Florida and informal surveys suggest that two of every three refinancing applications in the hardest hit states are for HARP loans.  

In January’s State of the Union Address the President laid out the final steps aimed at those borrowers who are doing everything right but still cannot refinance and this week there were three bills introduced in Congress to implement the rest of the President’s program.  The first, introduced by Senators Menendez and Boxer, would remove the barriers remaining for some 12 million borrowers with government-backed mortgages.  The legislation would help borrowers with second liens, cut red tape and costs such as eliminating manual appraisals, and would increase competition.  

Donovan said that currently the servicers who are already handling a mortgage have an incentive to refinance it but other lenders don’t.  The goal is to remove the last bar to cross-servicer competition by extending the same streamlined underwriting currently enjoyed by the existing lender to the rest of the market.   This would also extend streamlined refinancing steps to all GSE borrowers including those with significant equity and thus less credit risk.  

Donovan stressed that these changes are a positive for taxpayers.  First they will pump billions of dollars into the economy   but they will also lower risk by lowering payments, and ultimately eliminate some of the costs of loans that default.

The second piece of legislation, introduced by Senator Feinstein, would provide simple, low-cost refinancing opportunities to non-GSE borrowers by extended streamlined refinancing to those who have been paying on their mortgages but have private label or bank loans.  The new mortgages would be run through the Federal Housing Administration and open up today’s low rates to an estimated three to four million families.  Donovan said that this program is an issue of fairness; many responsible borrowers who have done everything they were supposed to do are still unable to refinance simply because of who owns their loan.

The third piece of legislation proposes to give underwater borrowers who decide to refinance a choice of taking the reduced interest in the form of a lower monthly payment or applying those savings to rebuilding equity in their homes.  To encourage borrowers to make the latter choice the legislation would cover the closing costs of borrowers, a benefit of about $3,000 per homeowner on average.  Taking this course of action would give the majority of underwater borrowers the chance to get back above water in five years or less.

During the question and answer session Donovan was asked about pay-fors for the provisions and said that, while the President had made a proposal to cover the expected cost, the administration is open to looking at other suggestions. 

Another reporter referenced a remark from Senator Boxer that Acting Federal Housing Finance Administration (FHFA) Director Edward J. DeMarco already possesses the authority to implement some of the proposals in her bill.  Donovan said that FHFA was looking at the idea of eliminating manual appraisals and there might be other provisions, but he added that there is an urgency to the President’s proposals.   All of them would help boost the economy, he said, and there is no way of knowing how long we will have these low interest rates.  “We need to move the legislation, not wait for an FHFA analysis.

In addition to the refinancing initiatives laid out by Donovan, the “to do list” the President will detail today contains the following:

  • Legislation that gives companies a new 20 percent tax credit to cover costs of moving their operations back to the U.S. This will be paid for by eliminating current tax incentives that allow companies to deduct the costs of moving their businesses abroad.
  • Legislation that gives a 10 percent income tax credit for firms that create new jobs or increase wages in 2012 and that extends 100 percent expensing in 2012 for all businesses.
  • Legislation that will extend the Production Tax Credit to support American jobs and manufacturing and an expansion of the 30 percent tax credit for investments in clean energy manufacturing.
  • Legislation that creates a Veterans Job Corps to help Afghanistan and Iraq veterans get jobs as police, firefighters, and other jobs to help their communities.

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DeMarco Discusses the Future of FHLBanks

Edward J. DeMarco, Acting Director of the Federal Housing Finance Agency (FHFA) told Federal Home Loan Bank (FHLBank) directors yesterday that their Banks’ proven ability to access global markets could play a large role in their future.  DeMarco spoke to the directors as they met in conference in Washington, DC.

DeMarco said that most FHLBanks had emerged from the recent crisis in relatively good condition and all 12 were profitable last year.  Retained earnings have increased dramatically in the past five years and now top $9 billion and should continue to increase as a result of the capital plan provisions adopted last year to set aside 20 percent of income in restricted retained earnings.  The quality of assets held by the Banks has also improved as holding of private label mortgage-backed securities (MBS) have declined.  Credit-related other than temporary impairment charges on those securities also dropped in each of the last three quarters.  “In a reversal from just a few years ago, the market value of equity exceeds the par value of capital stock at most FHLBanks,” Demarco said.

The banks still face headwinds, the largest being the decline in the volume of advances, “and the outlook for advances growth is not promising in the short-term as members remain flush with cash and loan demand remains slack.”  Expenses have not contracted as fast as assets and advances and persistent low interest rates have reduced the return on invested capital, both contributing to weakened earnings.

Growth of membership over the past year has been concentrated among insurance companies.  Their collateral arrangements with the FHLBanks differ in some critical ways from those with insured depository institutions and, DeMarco said, these arrangements bear watching as does market risk, especially at Banks with large holdings of mortgages and MBS relative to assets.

In the current climate housing finance reform is a critical concern and, while the futures of Fannie Mae and Freddie Mac are central to that discussion, the FHLBanks should be part of it as well.  The Banks, DeMarco said, have long been a conduit to global capital markets and have enhanced the liquidity and funding of mortgages for decades.  “Expanding, maintaining, or refining that role will be the focus of the conversation as it pertains to the FHLBanks.”

There are more than $10 trillion in single-family mortgage loans in the nation, there are not enough deposits in the country to fund them all, and the risk management challenges for domestic financial institutions to manage all the associated risks in the portfolio are substantial.  The U.S. Housing market of the future, like the market today, needs access to global capital markets.

“A critical question for policy makers is how to build or rebuild the plumbing necessary to connect global market investors with individual families seeking a mortgage to buy a home,” he said.   FHLBanks have already demonstrated their scalability and their ability to access the markets, even during the height of the liquidity crisis.  By issuing debt into global markets the FHLBanks raise funds that support housing through funding advances for mortgages going into members’ portfolios.  The ready availability of advances also makes those mortgages more liquid than they would otherwise be, thereby reducing the liquidity risk in members’ mortgage portfolios.  This also allows the FHLBanks to issue market-worth letters of credit which, in turn, allows members to attract their own funds for use in housing finance.  “Furthermore, as market intermediaries, the FHLBanks now serve as facilitators in the securitization process, collecting mortgage loans from members for sale in the secondary market.”

The FHLBanks already have strong relationships, including a cooperative ownership structure, to their nearly 8,000 front-line local lenders and these relationships give the Banks an important role as market intermediaries.  This makes them well suited to be part of an evolving housing market.

DeMarco laid out three ways in the Banks might be affected by moves to rebuild the housing finance infrastructure.  Congress could choose to expand the FHLBanks’ permissible business activities and such expansion might also require a review of the System’s capital structure and requirements and its approach to risk management.  Congress could choose to add some limits or restrictions on the Banks, essentially requiring some degree of contraction such as suggested in the Administration’s finance reform white paper by way of adding restrictions on the access of larger members to advances.  Or Congress could decide that the System is working well and leave it largely unchanged from where it is today.

If the decision is to stay the course, FHLBanks would remain focused on providing advances to members and providing a competitive and balanced finance and servicing system.  For members interested in retaining mortgages in portfolio the FHLBanks can continue to provide liquidity; for members interested in selling those mortgages, the banks have already demonstrated an ability to serve as a conduit to the secondary market.  And by serving as an aggregator in this process, the Banks are doing two important things; enabling community financial institutions to obtain better pricing and providing quality control by ensuring mortgages are securitized to meet the standards of the AMA programs.

DeMarco told the directors their most important role is to oversee and advise on the strategic planning process at their banks which means planning for the future.  For an organization to compete effectively it must build its strategic plan around its competitive advantage and for FHLBanks that advantage is their government-sponsored enterprise borrowing privilege.  It is the directors’ responsibility to product that privilege by using it to fund core mission activities safely and soundly.

DeMarco told the directors that the key to planning is to envision the future before it arrives.  Unfortunately, he said, because almost everything about the future is uncertain and unpredictable, “The question that faces the strategic decision-maker is not what his organization should do tomorrow.  It is ‘What do we have to do today to be ready for an uncertain tomorrow?’   “This,” he told the directors, “is your role.”

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