More and More Experts Say Principal Reduction Is the Answer

Why does the head of Fannie Mae and Freddie Mac refuse to consider it?

Last week, a group of Democrats from the House sent a letter to Edward DeMarco (who currently heads up the agency (FHFA) that oversees Fannie Mae and Freddie Mac) asking for a better answer as to why he refuses to implement a principal reduction program at Fannie and Freddie.

The letter cites industry experts, all of whom advocate principal reduction as necessary to bring the housing market and economy out of the dumps, including:

• Chairman of the Fed, Ben Bernanke
• a former Chairman of the Council of Economic Advisers
• a former Vice Chairman of the Fed
• a former Special Inspector General for the Troubled Asset Relief Program

Even Greg Lippman, the former Deutsche Bank AG trader who made a fortune betting against subprime mortgages, has weighed in on the side of mortgage reduction. Now chief investment officer for a New York-based hedge fund, Lippman wrote a letter to investors saying “principal reductions are necessary to help ameliorate the housing crisis.” (For more on Lippman’s perspective and additional expert opinions, read this Bloomberg News article.)

DeMarco claimed in a Nov. 16^th hearing that his agency has “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.” (For a great summary of DeMarco’s exchange with Rep. John Tierney (D-MA), read this post on Fire Dog Lake.)

According to the Democrats behind the letter, DeMarco has too long been spouting “superficial excuses about why principal reduction programs are not feasible at Fannie Mae and Freddie Mac, despite a growing chorus of economists and other experts who believe these programs serve the long-term interests of taxpayers.”

Felix Salmon, an award winning financial journalist, boils the likely real reasoning behind DeMarco’s stance down to the following:

If we [the FHFA]do principal reductions, the accounting conventions finally grow some teeth, and we’re forced to take a write-down. Since we don’t want to recognize reality and take that write-down, we’re simply going to avoid doing principal reductions instead.” (read Salmon’s full post on “Ed DeMarco’s Obstructionism” here)

The Democrats’ letter calls for DeMarco to provide documentation that proves there are statutory provisions preventing FHFA from letting Fannie Mae and Freddie Mac reduce mortgage principal. In addition, they asked DeMarco for an analysis that compares the financial implications of foreclosures with the cost of debt reduction. DeMarco’s deadline to provide these documents is December 9^th.