CA AG Harris Attacks FHFA’s DeMarco on Principal Reductions

CA AG Kamala Harris
California Attorney General Kamala Harris has been awfully quiet amid pressure from the Obama Administration to agree to a settlement with the big banks over foreclosure fraud. So it’s interesting that she popped up this week to call for the resignation of Ed DeMarco, the head of the Federal Housing Finance Agency.

California Attorney General Kamala Harris has called on the head of the agency that houses Fannie Mae and Freddie Mac to “step aside” if he continues to refuse to reduce mortgage loans for underwater homeowners.

“It has become clear to me that the only way to keep distressed California homeowners in their homes is through meaningful principal reduction,” Harris said in a statement Thursday […]

Harris’ pressure on Edward DeMarco, who oversees Fannie and Freddie as the acting director of the Federal Housing Finance Agency, serves to further highlight the inadequacies of a deal that does not include Fannie and Freddie, although they own half of the mortgage debt in the country.

Some of my colleagues have characterized this as Harris doing the dirty work of the Administration. They don’t like DeMarco, in this telling, because he’s tough on the banks; witness the FHFA lawsuit against 17 financial institutions over misrepresentations on mortgage-backed securities purchased by Fannie Mae and Freddie Mac.

I think it’s a bit more complicated. First of all, DeMarco is a bottom-line guy. He views the FHFA mandate very narrowly. He wants to limit taxpayer exposure to Fannie and Freddie, and that’s it. Now that’s a good thing when he sues the banks over representations and warranties, because he’s trying to recoup money on agency MBS. But it’s a bad thing when he refuses to allow the GSEs to give principal reductions to homeowners with Fannie and Freddie-backed loans, which has been the case since March. This is how I put it then: [cont’d.]

The FHFA (Federal Housing Finance Administration), which oversees Fannie and Freddie, has rejected a government-administered principal modification program, because their mission is to minimize losses to the taxpayer in the short-term, and mods would reduce the overall portfolio value. But houses in foreclosure do nothing for Fannie and Freddie’s bottom line, either. FHFA is also seeking put-backs on mortgages on the banks, also to reduce taxpayer exposure, but we see with their rejection of principal mods that the sword is double-edged […]

Basically, by refusing to modify principal, traditionally the most sustainable modification, FHFA is setting off a death spiral, where home values continue to drop because of foreclosures, and borrowers go more underwater, leading to more foreclosures. With Fannie and Freddie holding so many mortgages, they are a serious impediment to a more stable solution to the foreclosure crisis.

Here’s where this gets interesting. If FHFA maintains this position, it has a major effect on any global settlement. The way a settlement would work, according to reports, is that the banks would have to fill a quota of a certain amount of principal reductions or refinances on underwater loans. But if FHFA denies such a measure, then over half the mortgages in the country would not be part of the settlement. The banks would only be able to extend their credits to bank-owned loans, or loans owned by outside investors.

This would be a bad deal for California. There are very few bank-owned loans here, because Countrywide, a major player in the state during the bubble years, securitized almost everything they got their hands on. So Harris, by asking DeMarco to step aside, may be asking him to participate in the settlement.

To be clear, I want DeMarco to allow principal mods on loans the GSEs own or guarantee, because it’s the only way to fix the housing crisis. Former Deutsche Bank trader Gregg Lippmann, who famously bet against subprime mortgages during the height of the bubble, has come around to that reality. Joe Nocera has a good opinion column on this today. It’s the right thing to do. And it’s good that Harris is focused on principal reductions as the key step.

But in the context of the settlement, it’s a different story. This sounds to me like Harris is demanding that DeMarco relent on principal reductions so those loans can be included in the settlement terms. Then the banks can spread the $20 billion earmarked for principal mods across the full suite of loans. I’ve already discussed at length why the terms for the settlement are shockingly weak, and why a settlement on ongoing activity without an investigation to plumb the depths of it is flat-out wrong.

It’s also important to note that DeMarco could simply grant principal mods under the existing Principal Reduction Alternative run by the Treasury Department. It doesn’t have to be part of a settlement at all.

This is just one explanation of Harris’ motives in going after DeMarco. But if it’s right, then DeMarco’s unwillingness to allow principal mods could be what keeps Harris out of the settlement – which in all likelihood keeps the settlement from happening.