The Federal Housing Finance Agency has conceded that the higher incentive payments the Treasury Department is willing to pay make principal reduction cost effective for Fannie Mae and Freddie Mac.
Looking at a pool of 700,000 delinquent loans, FHFA analysts estimate principal reduction modifications, compared to principal forbearance, would reduce GSE losses by $1.7 billion.
FHFA currently permits modifications where the servicers temporarily forbear on a portion of the principal and interest payments -- but not modifications where principal is permanently reduced.
Because Fannie and Freddie would receive the triple incentive payments for principal reductions, it produces a "better" result for the GSEs, FHFA acting director Edward Demarco said at a forum on principal reduction sponsored by the Brookings Institution.
This is what Obama administration officials and congressional Democrats have been waiting to hear. For several months, they have been ratcheting up the pressure on the FHFA director to permit HAMP principal reductions.
However, the GSE regulator is concerned principal reductions targeted on delinquent borrowers will create an incentive for other GSE borrowers to default.
There are two million underwater borrowers with Fannie and Freddie loans that are current on their mortgages.
"Encouraging their continued success could have a greater impact on the ultimate recovery of housing markets and cost to the taxpayers than the debate over which modification approach offered to troubled borrowers is preferable," DeMarco said Tuesday morning.
In considering whether Fannie and Freddie should forgive principal or not, DeMarco said the agency will have to look at the effects on current borrowers and operational costs.
The FHFA director is expected to make his decision on a principal reduction this month.
