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The housing sector isn't helping matters. 11 million Americans are now underwater on their mortgages, and some believe it's time for more dramatic solutions. The idea of reducing the principal on those loans used to be a fringe concept embraced by few outliers. But today, many policymakers believe it's necessary to keep some troubled homeowners afloat. As NPR's Yuki Noguchi reports, the nation's biggest holders of mortgages - Fannie Mae and Freddie Mac - have yet to embrace the idea.
YUKI NOGUCHI, BYLINE: Housing and Urban Development Secretary Shaun Donovan argues Fannie and Freddie should be writing down principal.
SECRETARY SHAUN DONOVAN: We do think principal reduction is a step that's important. That can be good both for homeowners and for taxpayers.
NOGUCHI: But the idea has critics, including the administration's own acting director of the Federal Housing Finance Agency. The FHFA took over Fannie and Freddie in conservatorship three years ago when the financial crisis prompted a massive bailout of the companies. Edward DeMarco is that acting FHFA director. He, along with Donovan, spoke in Washington today at an event co-sponsored by the National Journal. DeMarco says Fannie and Freddie have modified a million loans using other means.
EDWARD DEMARCO: There's one form of loan modification that they are not pursuing and that is principal forgiveness. But that does not mean that we are not making great efforts to assist troubled homeowners in underwater mortgages that have an ability to meet a mortgage obligation.
NOGUCHI: DeMarco argues it doesn't matter how you restructure home loans so long as the payment amount decreases. Fannie and Freddie are doing this, he says, through forbearance of principal, that is charging no interest and deferring payment on principal amounts into the future.
DEMARCO: This is an efficient way to provide assistance to the borrower, keep them in their home, but if the borrower remains successful in this modified loan, it preserves for the American taxpayer an ultimate recovery on the debt.
NOGUCHI: Moreover, DeMarco says, current law doesn't give him the authority to forgive principal, even if he saw fit to do so.
DEMARCO: If there's a larger macroeconomic or public policy purpose to be served by using taxpayer resources to provide debt forgiveness for certain homeowners, that's the judgment of elected officials.
NOGUCHI: DeMarco and other critics of principal reduction say any policy that appears to pick and choose possible beneficiaries creates what's known as a moral hazard. In other words, it creates perverse incentives for people to deliberately renege on their obligations in the hopes of qualifying to get some of their home loan forgiven. But HUD Secretary Donovan says not reducing principal creates its own moral hazard issues. Namely, every time a home goes into foreclosure, neighboring homes decline in value, which means they end up holding the bag.
Donovan argues forbearance of principal doesn't create enough of an incentive for homeowners to keep paying their mortgages, especially in cases where they are deeply underwater.
DEMARCO: If you have somebody who's going to pay for 10, 15 years and still isn't building any equity in their home, what kind of message are you sending there? What's the moral hazard there? And so from my point of view, all these efforts on refinancing, on principal reduction for the folks who are doing the right thing is going to solve a moral hazard.
NOGUCHI: John Dilorio is CEO of 1st Alliance Lending, a company that banks hire to refinance and reduce principal on some of their loans.
JOHN DILORIO: They make the decision that refinance and principal reduction is more financially advantageous to them than foreclosure or short sale. So how can that be the position of the private marketplace but not the position of the conservator of Fannie and Freddie who are in control of far more assets?
NOGUCHI: Meanwhile, Fannie and Freddie are not party to a recent settlement between major banks and state attorneys general. It included a deal for banks to write down $17 billion worth of homeowners' principal. California Attorney General Kamala Harris says that means her work is not done.
KAMALA HARRIS: The settlement that we reached with the five big banks was good, but it was only one part of the whole issue.
NOGUCHI: Harris says she'll continue to work with other state AGs to put pressure on FHFA to change its position. Yuki Noguchi, NPR News, Washington.
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