Federal Mortgage Mods: Fannie and Freddie Bail Out More Borrowers

The official line from the government's overseer of Fannie Mae and Freddie Mac, the Federal Housing Finance Agency (FHFA), is that it's "still in the enterprises' best interest to do a mod." Changing a loan might lead to losses of 10 percent, an official there said. A foreclosure would be more like 50 percent.

The math on that doesn't make much sense – unless FHFA actually thinks that most of those homeowners seeking breaks on their loans are at a real risk of foreclosure, even though their monthly housing costs are affordable by almost anyone's standard.

That should make all of us nervous. Fannie and Freddie appear to be reacting to the wave of walkaways: Homeowners who look at their mortgage bills and decide that they're paying too much for homes that have declined greatly in value. Economists call this "strategic default," and by some calculations they account for more than one in five foreclosures.

Research on strategic defaulters suggests homeowners who are likeliest to take the plunge are those in markets where prices have dropped dramatically. After all, assuming housing prices return to their historic rates of increase, it could take decades to get back to a net-positive situation. And meanwhile alternative real estate is available to rent or eventually buy at much lower cost. Many borrowers take a cold look at the numbers and decide to bail.

We know Fannie and Freddie are scared of walkaways. Last month, Freddie Mac Executive Vice President Don Bisenius scolded strategic defaulters on the company's website, noting that they not only hurt their own neighborhoods by lowering property values but also make it harder for everyone to get mortgages:

"Should strategic defaults become more common, mortgage guarantors and investors, including Freddie Mac, would need to factor this risk more prominently into their credit policies and prices. The likely impact on future homebuyers: The cost of a mortgage will go up and credit terms will be less flexible. Thus, the impact of strategic defaulters on still more families might be more expensive mortgages and loans that are more difficult to obtain."

Since Fannie and Freddie are just now starting to offer loan mods to borrowers who ought to be able to pay, they most likely expect housing prices to continue to decline in many markets, pushing more borrowers to strategically default.

The loan modifications that Fannie and Freddie now are offering to borrowers who didn't make the cut for HAMP won't help those getting aid escape negative-equity territory. The mods typically will offer reduced interest payments and deferred fees, not cuts in principal owed, so borrowers will owe piles of payments for years to come.

But what the loan mods will do is lower the size of the checks that borrowers have to write each month – and Fannie and Freddie seem to hope that this little bit of pain relief will be enough to make homeowners think twice about defaulting on mortgages.