Look Who’s Not Included in Mortgage Settlement

The $25 billion settlement struck with the five major mortgage banks has a couple of notable players absent in the settlement—Fannie Mae and Freddie Mac.  Any homeowner with a mortgage bought by Fannie or Freddie will not be eligible for mortgage relief under the deal.  The two mortgage giants control over half of the mortgage market. Why would their mortgagees be left out?

The simple answer is, the GSE’s conservator, Federal Housing Finance Agency’s acting director, Edward J. DeMarco, did not want the GSEs involved. The reason for DeMarco’s decision not to participate is his firm belief that principal write-downs are a bad idea.  He has banned Fannie and Freddie from approving any write-down deal and the Robo-Signing settlement includes billions to support such write-downs by the participating banks.  He maintains he would be violating federal laws that require the GSEs to minimize losses if he approved a principal reduction plan.  DeMarco says principal reduction is the second most costly alternative after foreclosure in resolving a potential default situation.

A recent Los Angeles Times article claims DeMarco’s reasoning is faulty because principal reduction has been proven to be the most effective tool in keeping distressed homeowners from defaulting. When people are close to breaking even or have equity they fight harder to hold on to their home.  Those who see no hope of gaining back home equity and then run into a financial difficulty are likely to see default as the most reasonable option.

The New York Federal Reserve has calculated that when a mortgage with 18% negative equity is subjected to a principal write-down the probability of re-default falls 40% within a year of modification.  That makes principal reduction 4 times more effective at preventing default than any other loan modification method.