Ed DeMarco, acting head of the Federal Housing Finance Agency (FHFA), doesn’t have the look of a comic-book super-villain, but if you listen to some of the barbs his critics hurl at him, DeMarco is more dastardly than The Joker or Magneto. Peter Goodman, Business Editor at the Huffington Post has called DeMarco “America’s most dangerous man.” The liberal activist group MoveOn has been petitioning for DeMarco’s ouster writing, “What would it take to save millions of homes and billions of dollars in taxpayer money? Replacing one man—Ed DeMarco.”
That’s pretty harsh stuff. So what is getting DeMarco’s (mostly left-leaning) critics all bent out of shape? DeMarco has repeatedly fought back against calls for Fannie Mae and Freddie Mac, the Government Sponsored Enterprises (GSE’s) overseen by the FHFA, to forgive underwater homeowners some of the principal they owe. For these critics, principal forgiveness is a win-win. Homeowners would see the amount they owe on their home drastically reduced, but the taxpayers who now own Fannie and Freddie would benefit too because principal forgiveness is the best way to avoid a costly foreclosure process. Proponents of principal reduction also believe that it would be a great way to stimulate the economy. As TIME’s Bill Saporito has argued, ridding American homeowners of some of its $700 billion in negative home equity would be a huge boon to the economy by making homeowners more confident to invest or take on new debt, and by enabling people to move to find new and better work opportunities.
So why has DeMarco been so steadfast in his opposition to this approach? First of all, he doesn’t agree with the principal reduction crowd’s math. He has repeatedly argued that reducing principal won’t prevent more foreclosures, and will cost taxpayers more than methods the FHFA is already using to keep people in their homes. As for the stimulus argument, he is sticking to the mandate Congress gave him – which dictates he must protect taxpayer assets and promote stability and liquidity in the housing market. Notice this doesn’t say anything about using Fannie and Freddie to implement stimulus strategies.
DeMarco seems to be taking the criticism in stride. Unlike many of the left’s other financial crisis arch-villains, you can’t really accuse DeMarco of acting out of greed or self-interest. A career civil servant, Mr. DeMarco could probably take his Ph.D in economics and go make a great deal more money working in private-sector housing finance. He is enduring withering criticism from the left while putting up with a frustrating lack of action from Congress. By all appearances, DeMarco is an economist who has studied the problem at hand, and believes he is not only obeying his Congressional mandate, but also pursuing the best path forward for the housing market.
Yesterday, DeMarco took to the Brookings Institute to defend his beliefs. In his speech, he provided an overview of the many programs FHFA has offered, in conjunction with the Treasury Department, to try to keep people in their homes while offering them some form of relief. He presented the results of previous FHFA analyses, which showed that using principal forgiveness, as opposed to other methods like principal forbearance, is more costly to the taxpayer and doesn’t necessarily do more to keep homeowners in their homes.
In December of last year, the Treasury Department, using leftover funds from the TARP bailout, tripled the incentives for home-loan modifications. Given these new incentives, DeMarco has changed his tune a bit. In his speech yesterday, he revealed a new analysis showing that principal reduction may actually save the GSEs more money than other methods of foreclosure prevention. The net benefit to taxpayers, however, might be negligible, since these Treasury incentives are ultimately coming from the taxpayer as well.
Even given these new developments, DeMarco was hesitant to endorse principal reduction as a strategy for healing the housing market. One reservation is the up-front cost to the GSEs for implementing new systems for principal reductions. If the programs the FHFA currently has are already working, DeMarco argues, there is no need to spend time and money developing new systems for preventing foreclosure. Second, DeMarco is concerned that if the FHFA begins a widespread principal reduction program, borrowers will be incentivized to become “strategic modifiers.” That is, borrowers may try to manipulate the system by missing payments they can afford to make, or otherwise try to appear to be in financial hardship, in order to qualify for principal reduction.
In a panel following DeMarco’s speech, there was some pushback to DeMarco’s arguments. Andrew Jakabovics, senior director at Enterprise Community Partners, argued that DeMarco was overstating the risk that borrowers would strategically default. Given the complexity of the factors that determine which borrowers would qualify for principal forgiveness and the other considerable incentives homeowners have to stay current on their loans, Jakabovics thinks that strategic defaults would be rare. Furthermore, he maintained that principal forgiveness is necessary for the housing market as a whole, and by allowing what’s owed on mortgages generally to reflect what the houses are actually worth, the FHFA would promote a much more healthy economy.
While there may be arguments that widespread principal reduction would be good for the economy as a whole, DeMarco clearly does not want to go down that road without further Congressional action. The FHFA will come out with a final analysis of this approach given the new Treasury Department incentives in the coming weeks, but if DeMarco’s speech is any indication, principal reduction will not be a large part of the agency’s strategy going forward. So if you’re in the camp that believes in this kind of action, DeMarco may indeed be your public enemy #1.
Of course, we do have a Congress that could fix this at any time, if they were motivated to force DeMarco to act.