Menendez, Reed, Warner, Merkley Lead Call for FHFA to Fix Flawed Study on Principal Reductions

Menendez, Reed, Warner, Merkley Lead Call for FHFA to Fix Flawed Study on Principal Reductions

Taxpayers and homeowners deserve fair and complete answers, the Senators wrote

Washington - U.S. Senators Robert Menendez (D-NJ), Chairman of the Housing Subcommittee, Jack Reed (D-RI), Chairman of the Securities Subcommittee, Mark Warner (D-VA), Chairman of the International Trade and Finance Subcommittee and Jeff Merkley (D-OR) today led a group of 30 Senators in calling on Acting Director of the Federal Housing Finance Agency (FHFA) Edward DeMarco to provide Congress with an accurate analysis of the effects on taxpayers of using principal forgiveness versus other mortgage modification options such as principal forbearance for loans backed by Fannie Mae and Freddie Mac. In a letter to DeMarco, the Senators pointed out a series of flaws in the agency's previous analysis and asked for an accurate analysis within 30 days, calling it "not only part of your responsibility as conservator to conserve taxpayer assets, but also part of your statutory responsibility to maximize assistance for homeowners to minimize foreclosures."

"We believe that the analysis has several critical flaws and also has not been updated for new developments," the Senators wrote. "We respectfully request that FHFA update its initial study, refining the earlier analysis and including new developments - especially the Administration's tripling of incentives for principal reduction. We believe that FHFA must be fully transparent with this new analysis and look at targeted solutions for borrowers in different situations, rather than the 'all or nothing' approach that was used in the previous analysis."

Witnesses at a recent Senate Housing Subcommittee hearing chaired by Senator Menendez testified that the FHFA's original analysis failed to consider whether Fannie and Freddie loans had mortgage insurance or not, failed to use real world principal reduction data, and had a variety of other technical flaws that could have changed the outcome of FHFA's analysis.

The letter was signed 30 Senators: Menendez, Reed, Merkley, Warner, Whitehouse, Wyden, Brown, Kerry, Shaheen, Levin, Carper, Feinstein, Franken, Durbin, Coons, Lautenberg, Akaka, Bennet, Bingaman, Schumer, Begich, Pryor, Boxer, Sanders, Cardin, Cantwell, Blumenthal, Gillibrand, Leahy and Murray.

Click here to download a PDF of the letter.

Full text of the letter:

Dear Mr. DeMarco:

We are writing to express our serious concerns with the recent analysis put forth by the Federal Housing Finance Agency (FHFA) on whether principal forgiveness would serve taxpayer interests, as compared to principal forbearance.

We believe that the analysis has several critical flaws and also has not been updated for new developments. We respectfully request that FHFA update its initial study, refining the earlier analysis and including new developments - especially the Administration's tripling of incentives for principal reduction. We believe that FHFA must be fully transparent with this new analysis and look at targeted solutions for borrowers in different situations, rather than the "all or nothing" approach that was used in the previous analysis.

While we appreciate the work that was put into the previous analysis, we believe the methodology should take into account recent expert testimony provided to the Senate Banking Committee's Subcommittee on Housing, Transportation, and Community Development on March 15th.

First, the original analysis did not consider mortgage insurance. At least one witness testified that a more complete analysis would have shown principal forgiveness to be a better alternative for loans without mortgage insurance. As noted in testimony, almost 70% of the seriously delinquent loans at Fannie Mae and Freddie Mac (the Enterprises) do not carry mortgage insurance.

Second, a hypothetical model (the Treasury NPV Model) was used for the analysis, rather than actual HAMP results. As you know, the HAMP Principal Reduction Alternative (PRA) went into effect in October 2010, so there should be more than 16 months of data on this forgiveness program available. Other sources of real world data should be considered as well.

Third, testimony indicated that there are several technical flaws that skewed the analysis. Specifically:

  • State level price indices were used, rather than Metropolitan Statistical Area indices. This likely resulted in an undercounting of high-LTV borrowers, and these borrowers are aided more by principal forgiveness than low-LTV borrowers would be.
  • The results were done on a portfolio level, rather than an individual loan level. Thus, an all or nothing approach was used in the analysis even though it's possible that principal forgiveness may yield better taxpayer results for certain categories of borrowers, while forbearance would be more appropriate for others.
  • The HAMP PRA program was not properly evaluated, leading to an analysis that overestimated the amount of principal forgiveness that higher income borrowers would receive.
  • The current profiles of borrowers should have been used, not borrower attributes at the time of origination. By relying on borrower characteristics at the time of origination, such as credit scores, the financial health of the borrower is inflated, which overstates the cost of forgiveness.

Fourth, and perhaps most importantly, since the time the original analysis was done, the Administration has tripled the financial incentives for principal reduction that are now available to the Enterprises. Since FHFA's own analysis concluded that principal forbearance would be only marginally better for taxpayers than principal forgiveness, it would not be surprising if this factor alone changed the results.

With respect to moral hazard concerns regarding principal forgiveness, the hearing witnesses discussed several ways to mitigate or eliminate this issue. Some of their suggestions that you could explore include using underwriting criteria that ensure that the borrower has a genuine hardship such as a documented drop in income or other comparable financial circumstances, permitting only those borrowers who met the eligibility criteria prior to the official beginning of the program to participate so that borrowers could not strategically insert themselves into the pool of eligibility later on, or using a shared appreciation modification that would improve borrower and lender incentives. Hearing witnesses also pointed out that in the private sector, banks, which seek to maximize their own shareholder returns, are using principal reduction as one tool for about 20% of their own portfolio loans. Finally, in response to claims that principal reductions unduly benefit junior lien holders, it is worth noting that at least one witness testified that as part of his firm's principal reduction efforts, all junior liens are extinguished, leaving the borrower with one lien.

We seek an accurate analysis but not a particular result. Conducting an accurate analysis of this issue is not only part of your responsibility as conservator to conserve taxpayer assets, but also part of your statutory responsibility to maximize assistance for homeowners to minimize foreclosures, and it is our responsibility in overseeing FHFA to ensure that FHFA conducts an accurate analysis. With taxpayers having subsidized Fannie and Freddie and with approximately 11 million homeowners underwater and several million seriously delinquent, the public deserves transparent, fair, and complete answers.

We request that this updated study be completed no later than 30 days after receipt of this letter, given the urgency and importance of this issue with underwater homeowners struggling every day. Please do not hesitate to contact us if you have any questions or if we can assist, and we look forward to your response.

Thank you for your kind attention to this important matter.

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Press Contact

Contact:

Tricia Enright 202.224.4744 (Menendez)

Chip Unruh 202-224-4642  (Reed)