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Tuesday, April 03, 2012

Update on Possible GSE Principal Reductions

by Calculated Risk on 4/03/2012 11:48:00 AM

Following a ProPublica story last week, Fannie and Freddie: Slashing Mortgages Is Good Business, there was some commentary suggesting that principal reductions would result in a windfall for banks holding 2nd liens.

Michael Stegman, Counselor to the Secretary of the Treasury for Housing Finance Policy responded: GSEs & Principal Reduction: How HAMP Helps More Underwater Homeowners (ht Dan)

Recently, various sources have alleged that large banks will get a windfall if Fannie Mae and Freddie Mac (the GSEs) reduce the principal balance on first lien mortgage loans that are owned or guaranteed by the GSEs. The claims arise from a concern that if the GSEs reduce the principal balance on a GSE first lien mortgage loan, any investor holding a second (and subordinated) lien on the property stands to benefit unfairly.

In fact, the principal reduction program that we have asked the FHFA to allow the GSEs to participate in, the principal reduction alternative of the Home Affordable Modification Program (HAMP), is designed to protect against exactly this result.

Of course, not all under water GSE loans have second liens. But if they do, under HAMP, where a first lien mortgage is modified, then the holder of an eligible second lien must modify that lien proportionately if they are a participant in the Second Lien Modification Program (2MP). ...

So quite contrary to providing a windfall to the banks, GSE participation in this program would force them to help homeowners even further by writing down these second lien loans.
The bank "windfall" argument was incorrect.

However a valid point was raised by Tom Lawler: The program might make sense to Fannie and Freddie only if the Treasury incentive is included. If that is the case, then the program might not make sense for taxpayers.

Principal reduction can be a very effective and cost saving program if done correctly, but I have to see the details of the proposal before deciding if this makes sense.