So another thing that happened while I was out of town was that Fannie Mae decided to get tough on "strategic defaulters"--people who default not because they can't make their mortgage payments, but because they'd rather spend the money on something more fun than an underwater house. This has triggered some outrage.
Felix Salmon writes:
When Fannie Mae got taken over by the US government, it became even more of an instrument of state policy than it was before. Today, Fannie Mae and its state-owned brethren (foremost among them Freddie Mac and the FHA) are responsible for funding the overwhelming majority of mortgages in the US: they essentially are the housing market, for most of us. So when it comes to the problems of default and foreclosure, it's crucial that Fannie Mae be part of the solution rather than part of the problem. Instead, it's decided to get onto a self-defeating moralistic high horse.
Whether or not this is self-defeating, I don't know why Felix is surprised by this outcome. Every poll I've seen shows that most people think that strategic default is wrong, and feel so rather strongly . . . so expecting the government to be on the side of the strategic defaulters is probably not very realistic.
Nor am I so sure that this is self-defeating. Felix and others have offered plenty of evidence that doing principal-reduction mortgage mods would be good for borrowers. But I've never seen much analysis showing that they'd actually be good for the lenders. Yes, a successful modification avoids foreclosure costs. But a good calculation would also have to include the following:
- The administrative costs of the modifications themselves. It's
easy to determine whether someone is in default or not. It's hard to
determine whether or not a) they need the modification b) how much
modification they should get and c) how much they can realistically pay.
- Some percentage of your modifications will redefault--somewhere from one third to more than half normally, though it's not clear what that number would be with sizeable principal reductions. In the case of redefaults, you have all the expenses of the modifications, plus the expenses of the foreclosure.
- The incentive problems: principal write-downs are not simply a
matter of writing down the principal of people who would have been
foreclosed upon, instead of foreclosure. Principal write-downs are
obviously much more attractive than losing the house, which means more
people will seek them, than will allow their houses to go into
Maybe write-downs on net benefit the banks. It seems just as likely that they don't--more likely, even. Which means the public policy question is whether we want to help folks who borrowed too much money on their houses, not whether this is "self defeating". Doing principal write-downs might well costs Fannie/Freddie, and by extension taxpayers, quite a bit of money. Is this what we'd like to spend that money on, when right now we can't even extend unemployment benefits?
Ezra Klein also argues that this is not sound business practice:
For one thing, a mortgage is a specific contract. It says that if the borrower stops paying, the bank forecloses on his or her house. It does not say that if the borrower stops paying because a massive recession has destroyed his or her home values and made it impossible to find a job in the area, he or she is barred from participating in the secondary mortgage market five years in the future.
Ah, but Fannie's secondary-market ban is not part of that contract. It may be (almost certainly is) aimed at stopping people from strategically defaulting on mortgages that Fannie already owns. But this doesn't alter the terms of an existing contract. Rather, Fannie is saying that it will use the fact of strategic default in evaluating whose loans it will buy in the future. This is not only perfectly legitimate; it ought to be standard practice.