On Feb. 19, 2009, CNBC editor Rick Santelli let loose on the floor of the Chicago Mercantile Exchange in response to President Barack Obama's proposal to subsidize underwater mortgages.
Santelli's famous rant gave birth to the tea party. Obama's proposal gave way to numerous initiatives, known by the catchy acronyms HAMP and HARP (but not HARM), all of which fell short of the administration's initial goals.
All is not lost, however. With housing on the mend, the president is determined to provide more taxpayer relief to homeowners. Last week, he nominated Rep. Melvin Watt, Democrat of North Carolina, to head the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac. The two government-sponsored enterprises collapsed in 2008 and were taken over by the federal government.
The FHFA's current acting director, Edward DeMarco, has refused to yield to White House pressure on debt forgiveness, claiming it would cost the companies, and hence taxpayers, too much. Watt, a member of the House Financial Services Committee, has publicly supported principal forgiveness. His views are more in sync with Obama's.
One is tempted to ask, why now? Housing is having its best run since the market peaked in 2006. It took two years after the end of the recession in June 2009 for housing to show some signs of life. Home prices took one more year to bottom. But now delinquencies and foreclosures are falling, the inventory of unsold homes is down, and sales, starts and prices are up. Investors are paying cash for cheap homes, making it harder for families looking for a home of their own to buy.
Three-quarters of deeply underwater borrowers -- those with a loan-to-value ratio of more than 125 percent -- are current on their payments, according to DeMarco. So why create perverse incentives by rewarding those who are delinquent with principal writedowns?
Meanwhile, the increase in prices is doing wonders for homeowners who owe more than their house is worth. In the past year, for example, the rise in prices pulled 1.7 million homeowners out of negative equity, according to CoreLogic, a residential-real-estate information and data provider based in Irvine. An additional 5 percent increase would give 1.8 million more homeowners positive equity in their homes, CoreLogic calculates. At the end of the fourth quarter, 10.4 million, or 21.5 percent of all residential properties with a mortgage, were underwater. Less than half are GSE-held mortgages and are concentrated in five states.
In the old days, principal forgiveness was a decision between borrower and lender. Foreclosure is an expensive process, and banks generally aren't interested in becoming property managers. It behooved both parties to come to agreeable terms on either a mortgage modification or outright debt forgiveness. Securitization changed all that, with multiple parties owning tranches of mortgage-backed bonds creating legal impediments.
Nowadays, Fannie Mae and Freddie Mac own or guarantee more than half the mortgages outstanding in the U.S. As conservator of the two companies, DeMarco is cognizant of his legal responsibilities. As he has said many times, FHFA's job is "to preserve and conserve the assets of the Enterprises and in their current state that translates directly into minimizing taxpayer losses."
Last year, the FHFA examined the economic impact of principal forgiveness for underwater borrowers and concluded that the anticipated benefits didn't outweigh the costs -- not to mention the risk that those current on their mortgage payments would become delinquent in order to qualify.
The Congressional Budget Office weighed in with its own analysis of the options on principal forgiveness last week, which it found would result in "small savings" to the government, "slightly reduce" foreclosure and delinquency rates, and "slightly boost" economic growth. (Several articles cited the CBO study but selectively omitted the qualifiers.)
Mortgage modification of any kind comes with moral hazard attached. It rewards those who binged on too much debt to buy too much house. Principal forgiveness takes it to another level, especially when it's imposed by the government, with the taxpayer footing the bill.
Both supporters and opponents of principal reduction have a legitimate fairness argument. The pro case goes something like this: Banks got bailed out based on the idea that helping Wall Street benefits Main Street. (Main Street is still waiting to see that benefit.) By the same logic, helping homeowners get out of debt may speed the economic recovery.
The con argument is as follows: Many underwater homeowners are trying their best to stay current on their mortgages, in some cases working two jobs to make ends meet. Why should delinquent borrowers, whether by choice or necessity, have their debt reduced? It lessens the incentive for those who are current to keep paying.
"We have done so many things that are offensive to taxpayers and citizens and that create moral hazard in so many ways and in so many places," said Michael Carliner, an economic consultant specializing in housing. "This would be just another one."
That's one way to look at it. Another is that the market is fixing the problem by itself. By the time a new federal program is approved and implemented, and the kinks are worked out, it may be unnecessary.
Watt is far from a shoo-in for FHFA director. Some Republicans have called him unfit for the job based on his opposition to measures that would have strengthened Fannie Mae and Freddie Mac back in 2005. If he is approved by the Senate, expect the usual hue and cry from those who say debt forgiveness is promoting bad behavior.
Rick, are you ready to rant?
Contact Caroline Baum at email@example.com.