“NPR and ProPublica have learned that both firms have concluded that giving homeowners a big break on their mortgages would make good financial sense in many cases,” NPR stated in an article.

Edward DeMarco, acting director of the FHFA, has stood firm in his decision to not allow for principal reduction, despite mounting criticism from Democrats and petitioning from organizations to have DeMarco fired.
But, in a statement to ProPublica and NPR, ProPublica reported that DeMarco said, “As I have stated previously, FHFA is considering HAMP incentives for principal reduction and we have been having discussions with [Freddie and Fannie] and Treasury regarding our analysis.”

Despite the Treasury’s offer to provide incentives to the GSEs for administering principal reduction, DeMarco told lawmakers during a hearing on February 28 that “both companies have been reviewing principal forgiveness alternatives. Both advised me they do not believe that it is in the best interest of the companies to do so.”

While many contend that allowing the GSEs to apply principal reduction would help the housing market to recover and keep people from going into foreclosure, others argue that while 60 percent of all mortgages are owned or guaranteed by the GSEs, they account for roughly 29 percent of seriously delinquent loans.

Mark Calabria, director of financial regulation at the Cato Institute, showed support for the FHFA’s stance on principal reduction during a separate hearing March 15, where he pointed that GSE loans display a smaller percentage, just 9.9 percent of underwater loans, compared to private label securities, with 35.5 percent of loans underwater.
But, since principal reduction is considered as part of the HAMP modification, it has also been noted that the GSEs account for about half of all HAMP modifications.

During the fourth quarter of 2011, the FHFA reported about 19,500 HAMP trials became permanent modifications, which brought the total number of active HAMP permanent modifications to about 400,000.

Another argument used against principal reduction is its potential cost to taxpayers. FHFAs estimate is principal reduction will cost taxpayers $100 billion, in addition to the $180 billion rescuing the GSEs has cost already.

~DSNews

By Mark Calabria

In marketing Basel II to policymakers and the general public in 2004, bank regulators described the then proposal as “a three-legged stool” — offering a vision of stability where the financial system would be supported by three pillars.

Those pillars were minimum capital standards, an improved supervisory review process and increased market discipline. The financial crisis revealed serious faults in all three pillars.

Market discipline was jettisoned first. In fact, there is probably no characteristic that better defines the recent financial crisis and the government response to it than a rejection of market discipline. Companies could not be allowed to fail; creditors could not take losses.

The fundamental flaw of this third pillar was that it lacked an enforcement mechanism. Disclosure of risk is meaningless if market participants come to believe they will be protected from that risk by government. Nothing in either Basel II or III establishes a mechanism where creditors know with certainty that they will take losses. The “resolution” mechanism in the Dodd-Frank Wall Street Reform and Consumer Protection Act has so many holes as to lack any creditability.

In fact, both the Dodd-Frank Act and bank regulators have made it very clear that creditors will be protected. For instance, Dodd-Frank codifies the Federal Deposit Insurance Corporation’s guarantee of bank non-deposit debt. The Federal Reserve’s 13-3 powers remain largely untouched. There is no reason for creditors today to expect anything other than being bailed out.

If creditors were a small part of our financial markets, then perhaps their protection would only present minimal distortions. Yet even under Basel III, creditors will still be more than 90% of the funding for the typical financial institution. To insulate the vast majority of funding from any market discipline is to invite financial crises.

Recently attention has focused almost exclusively on the first pillar: increased capital. Unfortunately, this pillar is as damaged as the third. The increased capital requirements under Basel III are still nowhere near what the market would demand on its own.

When the next panic hits, market participants will again ignore “regulatory capital” and focus on common equity. We would be better off abandoning the facade of minimum capital standards and letting the market decide. It is hard to see the market demanding any less than what Basel III requires.

The first pillar of capital standards is also flawed in its management of relative risk weights. The favouring, if not actual subsidizing, of sovereign and mortgage debt not only remains, but is expanded, under Basel III.

It is no coincidence that these are also the markets that have suffered the most disruptions and required the largest bailouts. Any framework that treats debt issued by entities such as Fannie Mae and Greece as essentially risk-free is a framework that cannot be taken seriously. The current risk weighting, along with increased liquidity requirements, further insulates both governments and the mortgage market from much-needed market discipline.

The second pillar, supervisory review, has revealed itself as fatally unsound. It would be an understatement to say the world’s bank regulators were asleep at the wheel. Yet bank regulators appear, for the moment, to have awoken from their slumber.

It remains to be seen whether their attentiveness will last, particularly when the public and politicians demand that the next bubble be allowed to grow. We could greatly improve supervision if regulators themselves were subjected to accountability by, say, losing their jobs when the institutions under their care fail.

The Basel III process so far has indicated that bank regulators have learned almost nothing from the crisis. Many of the contributors to the crisis, including Basel II, are being expanded instead of being scrapped. At least this time around we’ll know that the stool we’re being asked to sit on doesn’t have any legs.

Financial Post
Mark A. Calabria is director of financial regulation studies at the Cato Institute and a former senior staff member of the U.S. Senate committee on banking, housing and urban affairs.