FHFA Says “NO” To Principal Reduction

Hitting The Wall

The Obama Administration’s latest attempt to manipulate the housing market hit a wall yesterday, with FHFA saying “no” to principal reduction.

Fannie Mae (FNMA) and Freddie Mac won’t forgive principal on delinquent mortgages they guarantee even as the U.S. Treasury Department offers them incentive payments for writedowns, the companies’ regulator said today.

Months of analysis showed there would be no clear benefit to taxpayers if the Federal Housing Finance Agency changed its policy barring the government-owned mortgage-finance companies from loan modifications including debt writedowns, Edward J. DeMarco, the agency’s acting director, said at a briefing with reporters in Washington.

“We concluded the potential benefit was too small and uncertain relative to unknown costs and risks,” DeMarco said.

Of course those on the left were immediately out claiming this decision was “political.”

I don’t buy it.

The problem with blanket programs of “amnesty” on principal value is that they tend to encourage strategic defaults.  Just like the market has “anticipated” and gamed every decision The Fed has made over the last five years as the economy went down the toilet, and the drug-addled equity market has done since, so would such a program encourage the same sort of game-playing and “anticipation.”

On balance this sort of game-playing is destructive, not constructive.  The fact of the matter is that for everyone who “wins” from such a program, someone must lose.  That “someone” would be the taxpayer, for such funds can come from only one place — more national debt.

To a large degree this is like taking a $20 from your left pocket and placing it in your right, then claiming you’re $20 richer.  You’re not, of course; all you’ve done is shift money around.  What’s worse is that due to frictional effects which exist in all economic transactions you actually make the system poorer.

And finally, the worst effect of all is that you retard and inhibit the loss of price in houses to sustainable levels — a place where people can buy a home without depending on the premise of “ever rising prices” to be able to afford it.

The fact is that houses, when used as a place to sleep, are a consumer durable good, not an “investment.”  They require constant input of more funds (and/or sweat) in the form of upkeep, and what’s worse state and local governments assess annual taxes on their ownership so they are all massive losers over the long haul.  Of course the counter-argument is that “renting includes these costs in the rent so you can’t escape” but the point isn’t escape — it’s what housing is, and how it impacts on the macro-level economy as a whole.

Economic balance requires that houses sell for about 2x annual incomes.  The fact of the matter is that houses are still “rich” to median incomes on this basis by about 30%; they would have to fall to about $100,000 in order to reach “fair value.”

Worse, this presumes a 20% down payment, and the percentage of homebuyers who put that away continues to be in the tank.  A big part of that is the insane leverage that we have heaped on college students via loans, destroying not only accumulation of capital for down payments but also payment capacity via the student loan payment that must be made first.  Subtract off the missing down payment from the median price if you’re looking at “lower” or “more affordable” down payments, as the 2x median incomes assumes 80% financing to call that “affordable.”  That would put the median home price, in a 0% down world, at $80,000!

This of course makes Realtors and others in the industry gasp; “that’s impossible!” they claim.  The blanching continues among county and state finance executives, who quickly calculate what happens when their revenue from property taxes goes down by 30% (or more.)

But not only is this sort of further price decline not impossible, it’s entirely reasonable from a historical basis, and it is likely to happen before the economic adjustment is all said and done.

The best way to encourage the economic adjustment that has to take place is to “eat our peas” and allow the defaults that should happen to happen, along with the price adjustments that come from it.  Along these lines we should be forcing mark-to-market for all held housing inventory on various balance sheets, especially bank balance sheets.  This would in turn force disgorgement into the market and discovery of the clearing price, which is essential if we are to restore health to the housing industry — and the rest of the economy.

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