Federal Housing Finance Agency Rejects Debt Forgiveness Program

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FHFA says statute prevents Fannie and Freddie from adjusting principal.

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The Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, reported to Congress last week that the agency will not institute a debt forgiveness program despite requests from top Obama Administration officials.   FHFA’s acting director, Edward J. Demarco, announced the agency’s decision in a letter to lawmakers, which included a formal analysis of the proposed plan.

DeMarco argued that the plan would have put Fannie Mae and Freddie Mac into a position of having to accept too much taxpayer money to justify adopting the program.

DeMarco stated that FHFA’s management of Fannie and Freddie is bound by federal statutes, specifically noting that the Housing and Economic Recovery Act of 2008 compels the FHFA to “take such action as may be (i) necessary to put the regulated entity [that is, Fannie and Freddie] in a sound and solvent condition; and (ii) appropriate to carry on the business of the regulated entity and preserve and conserve the assets and property of the regulated entity.”

The rejected plan, the Home Affordable Modification Program Principal Reduction Alternative (HAMP PRA), would help struggling homeowners who are behind on their mortgage by reducing the principal they owe to their lender. The program is funded through the Troubled Asset Relief Program (TARP) at the Department of The Treasury.

In order to participate, homeowners must owe more than their home is worth, face financial hardship, and meet other eligibility criteria. Several major lenders, including JP Morgan Chase, Wells Fargo, and Bank of America are already participating in the HAMP PRA program.

The FHFA interprets a clause from the 2008 legislation, “preserving and conserving the assets of the regulated entity,” to require the agency to minimize expenses for taxpayers, taking into account the fact that the TARP incentives used to fund HAMP PRA cost taxpayer dollars. This interpretation in turn lowers the benefits of participation in the agency’s eyes.

DeMarco justified the FHFA decision on several grounds—noting that a pilot program involving principal forgiveness had less than stellar results, that the program would create a moral hazard encouraging homeowners to default on their mortgages, and that implementing the program would cost the agency and Fannie and Freddie significant time and resources. Prior to the July 31 decision, DeMarco outlined the Agency’s approach to the issue in an event at the Brookings Institution.

Some Republican lawmakers applauded the decision, stating that it would save taxpayers money. Representative Spencer Bachus (R-AL) supported it, telling the New York Times that DeMarco “deserves praise for standing up for the best interests of the American people.”

In contrast, some economists have argued that debt forgiveness is an important method of stimulating the economy. New York Times columnist and economist Paul Krugman even called for DeMarco to be fired in response to FHFA’s decision. He criticized the agency for not taking into account the possible stimulative effects of the program when conducting its analyses. Democratic lawmakers sounded frustration with the decision, and the U.S. Treasury Department has responded by urging FHFA to reconsider its decision.