There are ways the Federal Housing Finance Agency could structure a principal reduction program and prevent strategic defaults, which the agency is “deathly afraid of,” according to Laurie Goodman of the Amherst Securities Group.
“The FHFA has been just dead set against writing down GSE loans when they are nonperforming,” the ASG senior managing director told a seminar sponsored by Americans for Financial Reform.
That is because the agency is concerned it will encourage other underwater borrowers to default on their Fannie Mae or Freddie Mac mortgage to qualify for a principal reduction.
“There are easy ways to combat the moral hazard,” Goodman said.
The FHFA could announce the principal reduction program is starting in August 2012 and eligible borrowers had to be delinquent before May. “That way borrowers can’t go delinquent to qualify for the program,” she said at the June 28 seminar.
However, such an approach would restrict the number of borrowers who could qualify for a writedown that would make their payments more affordable and give them more incentive to stay in their homes. ASG research shows loan modifications with a principal writedown perform much better than other mods.
“A more eloquent solution,” she said, involves a shared appreciation mortgage, where the borrower gives up half of any future increase in the value of the property.
In exchange for writing down the loan to a 110% or 115% loan-to-value ratio, the borrower would share 50% of the upside with Fannie or Freddie.
A borrower with a 150% LTV who is very likely to default or already defaulted would gladly exchange 50% of the upside for a principal reduction. “That‘s a great deal,” she said.
But a borrower at 120% LTV, who doesn’t really need a principal reduction, will look at a writedown to 115% and conclude it’s a terrible deal.
“That is a more eloquent solution where the borrower is making economic decisions, not moral decisions,” Goodman said.
