A Huge Problem for New Federal Foreclosure Prevention Efforts

Fannie and Freddie, which the government now owns, may refuse to participate

Foreclosures have been slowing recently, but not because government mortgage modification programs are working. Instead, the banks have been struggling to revamp their procedures after flaws were exposed last fall. The federal programs continue to provide a mere trickle of modifications as homeowners either aren't qualifying or servicers aren't finding the incentives in place very enticing. Will revamping the programs help?

The Wall Street Journal's Nick Timiraos reports that the Obama administration is considering new options to prevent foreclosures:

Policy ideas include having taxpayer-owned mortgage giants Fannie Mae and Freddie Mac relax their rules for loans to investors, allowing those buyers to vacuum up excess housing inventory. In certain markets, Fannie and Freddie could hold some foreclosed homes off the market and rent them out to ease the property glut.

Officials also could sweeten incentives for banks to reduce loan balances for borrowers who are underwater, or owe more than their homes are worth.

Even if such new programs could help in theory, they may not work in practice. Despite taxpayers owning Fannie and Freddie, the government appears to lack either the will or the authority to force the companies to go along with its policies.

You can see this point clearly through the Treasury's current push for principal reductions. Earlier this month, it finally provided data for the program, in which servicers are provided incentives to write-down the mortgage balances of struggling borrowers. The report provided two clear takeaways: the principal reductions that occurred were fairly aggressive, but relatively few actually occurred.

Banks weren't expected to embrace the idea, as many have long complained that principal write-downs would do more harm than good. The big surprise, however, was that the market's two biggest players were ignoring the program entirely: Fannie and Freddie do not participate in any principal reduction. When asked about their rationale for this strategy, the Federal Housing Finance Agency, which controls the two companies, declined to comment.

Presumably, the Treasury would very much like Fannie and Freddie to participate in this program. After all, if the Obama administration didn't believe that this program was a good idea, then it wouldn't have created the effort. And yet, the two giant mortgage companies the government seized aren't being forced to participate.

This suggests that the proposed policy possibilities above that involve Fannie and Freddie could fall flat. Through the principal reduction program, we can see that the government isn't forcing Fannie and Freddie to comply with its policy initiatives. If Fannie and Freddie like an idea, then they'll go along. But if (for some reason that they may not even wish to publicly disclose) they don't like a proposed effort, then it's destined to fail.

The final idea above, which would provide additional incentives to encourage principal reduction, might not help much either. Since Fannie and Freddie own or guarantee such a huge portion of U.S. mortgages, their refusal to participate in principal reduction will dampen the potential effect of such a renewed effort.

This all points at a single question: why can't the government control Fannie and Freddie? It seized the companies, and taxpayers own them. Shouldn't it also have some say over the firms' strategies? Without the ability to force Fannie and Freddie to comply with government programs, any future efforts may have similar fate as past programs: they may be doomed to mediocrity.

Image Credit: REUTERS/Jason Reed