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Why Ed DeMarco is Right on Fannie and Freddie

August 10, 2012 J

By Jason Hughey

The first rule of government intervention in housing is that government should stop intervening in housing.  Prior to 2008, government interventions produced perverse incentives and unintended consequences that fueled a massive housing boom—a boom that ultimately turned to bust in the fall of 2008.  If we can learn anything from the subprime mortgage crisis, it is that bureaucratic government regulation of the housing market needs to be removed.

However, as long as such bureaucracies remain, the best thing we can hope for is the kind of behavior we currently are seeing from Ed DeMarco, the acting director of the Federal Housing Finance Agency (FHFA).  Despite a rising outcry from progressive critics, DeMarco has made a small step to prevent further government intervention in housing by refusing to allow Fannie Mae and Freddie Mac to provide principal reduction on their loans.  In doing so, DeMarco has defended American taxpayers from having to pay even more to cover for the fallout of the 2008 collapse.

The case for principal reduction rests upon the notion that taxpayers should cover the cost of underwater homeowners who owe loan payments to Fannie and Freddie.  It is argued that these homeowners should be forgiven much of the principal amount of their loans by having Fannie and Freddie cover some of the cost of the principal.  This policy would supposedly help stimulate the economy by relieving homeowners of their massive debt obligations on their mortgages.

In reality, this alleged solution poses numerous problems.

First, it requires American taxpayers to cover the cost of principal reduction after they have already paid for almost $200 billion to bailout Fannie and Freddie since 2008.  Under this proposal, they will be the unseen victims who are forced yet again to cover for the expenses of the highly visible and politicized GSEs.  Second, granting principal reduction to underwater homeowners will distort the incentives of borrowers to commit strategic defaults, increasing the cost to taxpayers beyond any original costs.  Third, granting this sort of principal reduction will set the precedent for destroying personal responsibility in lending, allowing borrowers to appeal to government for principal reduction rather than facing up to the debt they have accrued.  This policy could easily serve as precedent for bailing out individuals with a lot of student loan debt or credit card debt.

FHFA acting director Ed DeMarco understands these problems and sees through the criticisms of his opponents.  He understands that the money that Fannie and Freddie have received while under the FHFA’s conservatorship does not belong to him or the Obama administration.  Rather, the federal government had to coercively extract wealth from individuals and divert their money into Fannie and Freddie’s failing operations.  As such, DeMarco takes his responsibility seriously to ensure that the GSE’s conserve their taxpayer-funded capital instead of throwing it heedlessly at a solution that is, at best, highly problematic.

It doesn’t stop with principal reduction either.  Ed DeMarco has also come out against local governments and their plans for using the power of eminent domain to condemn underwater mortgages.  The local government in San Bernadino, California has been strongly considering this idea in order to buy up privately issued mortgages and refinance them.  DeMarco opposes these proposals because they also pose a significant cost to the taxpayers and violate the constitutional guidelines for eminent domain.

In taking these positions, DeMarco has faced strict criticism from President Obama’s administration, Secretary Geithner, and a number of political pundits, in spite of the fact that he has upheld his statutory mandate to protect and conserve the money that has already been taken from taxpayers.  In fact, a number of people have called for the President to instate a “recess appointment” for DeMarco (even though the Senate is not actually in recess) in order to get someone in charge of the FHFA who will immediately authorize Fannie and Freddie to reduce the principal on underwater loans and who will not oppose local governments if they attempt to use eminent domain to buy up bad mortgages.

Whether such a move will be made is yet to be seen, but it even further highlights the danger of federal oversight of housing.  Even if we can get a “good bureaucrat” like DeMarco in charge of an agency like the FHFA, his position is reliant on the political good will of the President and his administration.  So far, Demarco has done his job to protect the taxpayer, but inside the beltway, such a stance is usually punished rather than rewarded.

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