Sink or Swim

Mel Watt is a man under fire. Mr. Watt is the Director of the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, which in turn oversees most of the country’s home loans.

Watt is under fire because he is responsible for deciding whether to allow Fannie and Freddie to grant principal reductions for underwater homeowners, whose home loans are higher than the value of their house.

Despite improving Real Estate values, several million people are still in seriously deep water with little hope of reaching the surface any time soon. These people keep making their loan payments, but are stuck in houses they can’t sell and may inevitably fall into foreclosure or just walk away – unless their lender agrees to reduce the amount of their loan.

JoAnn Henderson, the subject of a recent news story, is underwater in her house which she bought in 2001. She refinanced her loan a few years later to a higher amount when her house appraised for $500,000. Her house is now worth less than $300,000 and she owes $450,000 on her loan. JoAnn got in trouble with her house payments when her employment changed and her income went down.

“I would miss a couple of payments, and then pay and pay,” she said. “And then I’d miss a couple more. Yeah, I almost lost the house.” JoAnn was granted a loan modification, which lowered her monthly payments, but she was not granted a principal reduction. She’s hanging in there for now, month-to-month, but still deeply underwater.

Joann’s situation is a typical example of the need for principal reductions, according to proponents who are firing at Mel Watt to make the decision to allow them.

“It seems like principal reduction is a logical no-brainer conclusion,” says a spokesperson for the Center for Responsible Lending. “FHFA’s own analysis found that allowing principal reductions on mortgages held by Fannie Mae and Freddie Mac could provide a potential benefit to these agencies, and a benefit to taxpayers.  In addition, principal reduction is already being used routinely by other mortgage holders.”

An Opponent to the idea that I talked to said, “Why give a free lunch to people who over-borrowed and spent the cash?”

Financial advisers Collingwood Group, say too much money would be lost on principal reductions. “This money doesn’t come out of thin air,” says Tim Rood, Chairman. “So it’s going to have to come from taxpayers and investors.”

What should Mel Watt do? Tell underwater homeowners to sink or swim? Or should he throw out the life preserver?