Mel Watt's nomination will impact mortgage REITs and originators

Part 2

As FHFA Chairman, Mel Watt would probably embrace principal mods

The current head of FHFA, Ed DeMarco

The current head of FHFA, Ed DeMarco, has steadfastly refused to consider principal mods because he views them as a losing proposition to the taxpayer. Many Democrats have openly called for his ouster, believing he stands in the way of the housing recovery. In reality, the argument for principal mods is more nuanced, and many on the Left have good reason to oppose principal mods as well. Principal mods make for good political theater, but there are other considerations.

HAMP modificationsEnlarge Graph

While those on the Left have criticized DeMarco for not doing enough to help distressed homeowners, DeMarco is at least a non-political technocrat. Many Republicans have said they want a non-political housing expert to run FHFA, and not a politician. While Watt has some experience on the House Financial Services Committee, he’s viewed as highly political and has even supported bankruptcy cramdowns, where a judge can unilaterally reduce a borrower’s mortgage. The idea was that the borrower could use the threat of a judge doing the mod to negotiate a better deal with the bank. This has proven to be another highly controversial proposal, in that it would make mortgages much more expensive and work against the housing recovery.

The Congressional Budget Office weighs in on principal mods

The non-partisan Congressional Budget Office weighed in on principal modifications and concluded that reducing principal would actually save the taxpayer money. The argument basically hinges on the idea that at least some of the borrowers would begin to start paying again, and something is better than nothing. Regarding the wave of strategic defaults, the CBO basically assumes it away, which is the weakness of the report. It assumes that the government will get it right when it drafts the modification rules, so there won’t be a wave of strategic defaults. This is reminiscent of the old joke where an engineer and an economist are stranded on a desert island with a can of tuna but are unable to open the can. The engineer tries to formulate a solution using rocks and tools. The economist’s solution is to “assume a can opener.” Suffice it to say the CBO assumed a can opener with respect to strategic defaults.

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