In a rare act of bipartisanship in a bitterly divided Congress, two House Democrats and a House Republican this past week introduced legislation that would help struggling homeowners avoid unnecessary foreclosure by reducing the balance they owe on their mortgages.
The bill—which Reps. Gary Peters (D-MI), John Campbell (R-CA), and Keith Ellison (D-MN) unveiled on June 8—would mandate principal-reduction pilot programs at the government-controlled mortgage financiers Fannie Mae and Freddie Mac, and at the Federal Housing Administration, a government-run mortgage insurer. For certain borrowers who are deeply “underwater”—meaning they owe much more than their home is worth—the entities would agree to write off some of the outstanding balance in exchange for a portion of any future price appreciation on the home, known as “shared appreciation.”
The borrower lowers his or her monthly payments and rebuilds the equity lost during the housing crisis, giving him or her a fighting chance of staying in their home. Meanwhile, the taxpayer-supported entities—Fannie Mae, Freddie Mac, and the Federal Housing Administration—will avoid the costly foreclosure process and will share in the benefit when home prices eventually recover.
The legislation echoes recommendations in our recent report, “Sharing the Pain and Gain in the Housing Market,” in which we laid out the case for targeted shared-appreciation principal reductions at Fannie Mae and Freddie Mac. Our report also proposed special rules for potential pilot programs that maximize returns to the companies and the taxpayers supporting them without creating skewed incentives for borrowers, many of which were adopted by the bill’s co-sponsors.
Specifically, the pilots created by the new bill would:
- Operate through the Home Affordable Modification Program, created in 2009 to help struggling homeowners modify their mortgages and avoid default: The Obama administration recently extended certain incentives for Fannie Mae and Freddie Mac to reduce principal through the program.
- Maximize returns to taxpayers: The borrower will only receive assistance if the net cost of the principal reduction is less than the net cost of a foreclosure.
- Focus on borrowers most in need of a principal reduction: Only deeply underwater homeowners that are seriously delinquent on their payments will be eligible for the program, and by forcing participants to give up a share of future home price appreciation, the write-down is not particularly attractive to borrowers who don’t need it.
To be sure, an act of Congress is not absolutely necessary to establish these programs; this power falls well within the authority of the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac as their government conservator. But the agency has long opposed principal reduction, generally barring Fannie and Freddie from offering write-downs on the loans they own or guarantee, with a few small exceptions.
That’s the case despite the agency’s own analysis showing that principal reductions would save the companies billions of dollars compared to other foreclosure-prevention efforts. By refusing to offer write-downs, Fannie Mae and Freddie Mac are significantly lagging behind the private sector; in the fourth quarter of 2011, banks used principal reduction for about one in four modifications on loans held in their own portfolios, according to the Office of the Comptroller of the Currency.
Since federal regulators refuse to act, it’s up to Congress to step up. This new bill, as well as a similar piece of legislation introduced by Sen. Robert Menendez (D-NJ) earlier this year, has the potential to help hundreds of thousands of struggling homeowners avoid foreclosure while saving taxpayer dollars. Instead of continuing a theoretical debate about costs, benefits, and unforeseen consequences, it’s time we tested the shared-appreciation model in the real world.
John Griffith is a Policy Analyst with the Housing team at the Center for American Progress.