Freddie and Fannie: Principal Reductions Make Sense

Freddie and Fannie: Principal Reductions Make Sense

Posted By Sulaiman Law Group, Ltd. || 23-Mar-2012

As first reported by Pro Publica and NPR News, Freddie Mac and Fannie Mae have released statements in favor of granting principal reductions on loans held by the two government sponsored entities (GSEs). Given that Freddie and Fannie currently hold 50% of the nation's mortgages, this is rather big news.

The statements aren't yet public, but appear to have been leaked from a source within the Federal Housing Finance Adminstration (FHFA), the agency that oversees the two GSEs. The logic behind principal reductions is sound. Taxpayers stand to gain over time if Freddie and Fannie write down the principal balance on underwater homes. This is especially true given the fact that underwater borrowers are more likely to walk away from their mortgages or enter foreclosure because making payments becomes too difficult.

Although granting principal reductions would reduce the overall face value of the loans held by Freddie and Fannie, this only reduces the American taxpayers' investment if every loan was paid in full the day after the reduction was granted. Mortgages are designed to be profitable over time -- depending on the interest rate, a lender can realize 2 to 3 times the face value of the loan or more in interest payments over the loan's lifetime. Keeping homeowners in their homes, but at a rate that they can afford to pay, means that those same homeowners will be paying interest over time. Those interest payments will easily recover the amount written down in the short-term.

In the past, I have been let down by the Administration's response to the housing crisis. At the risk of having a Charlie Brown moment, I'm going to go on record as hopeful. If the Administration (and Ed DeMarco, the director of the FHFA) commit to the idea that principal reductions will work, we may see this housing crisis end sooner rather than later.