Editor: David Reiss
Brooklyn Law School

May 6, 2013

Principled Forgiveness

By David Reiss

The Congressional Budget Office issued a report, Modifying Mortgages Involving Fannie Mae and Freddie Mac: Options for Principal Forgiveness, that reviews where we are with principal-forgiveness loan modifications. It notes that “Fannie Mae and Freddie Mac have not been allowed to implement principal forgiveness out of concerns about fairness, implementation costs, and the incentive that the approach could provide for people to become delinquent in order to obtain principal forgiveness.” (1)

The report examines how the GSEs could employ principal forgiveness. A key issue that the report addresses is how to deal with the moral hazard of homeowners “becoming delinquent in order to obtain principal forgiveness.” (3) This could result in large costs for the federal government and would be inequitable to those who are similarly situated who choose not to become delinquent.

The CBO analyzes three principal forgiveness options.  Each option would allow a GSE to choose between a standard HAMP modification or one that involved principal forgiveness, “depending on which one lowered the government’s expected costs more.” (3) CBO estimates that 1.2 million borrowers might be eligible for such a program, which would be about 40 percent of all underwater borrowers. CBO estimates that the federal government would save a modest amount of money with these options.

The CBO’s cost-benefit principle seems like a reasonable basis upon which to expand principal forgiveness loan modifications.  The FHFA should pursue these options even before its new leadership is in place.

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