PHILADELPHIA The vast majority of distressed homeowners should not be punished for the behavior of the few who might try to take advantage of a government program to reduce the principal on their mortgages, a top Obama administration official said on Thursday.
U.S. Secretary of Housing and Urban Development Shaun Donovan said a principal-reduction program could at any rate be designed to thwart those tempted to default strategically on mortgages financed by government-run agencies Fannie Mae FNMA.OB and Freddie Mac FMCC.OB.
"What we shouldn't do is punish the 95 percent for the behavior of a small group," Donovan said in an interview. "The answer isn't 'Don't do principle reduction at all.' The answer is 'Design it in a way to avoid that strategic default.'"
The White House has argued that principal write-downs could reduce delinquencies, help some of the 11 million "underwater" borrowers nationwide who owe more on their properties than they are worth, and get the struggling housing market back on track.
But the prospect of helping home buyers who some see as irresponsible has been sharply criticized as risking "moral hazard," or the abuse of largesse, an issue that helped spawn the Tea Party.
Edward DeMarco, acting director of the Federal Housing Finance Agency, has blocked the administration's plan because he says writing down loan balances would create a "moral hazard" in which many more borrowers might default in order to seek better mortgage terms.
The FHFA regulates Fannie and Freddie, which finances $5 trillion in mortgages, the bulk of those in the United States. The agencies were taken over by the government in September 2008 as mortgage losses mounted, and DeMarco says write-downs would drive up the cost of the $150 billion taxpayer bailout.
In April, the administration laid out the case for a program that would have safeguards against strategic defaults, in an effort to convince the FHFA to provide more mortgage aid.
Donovan said principle reductions are not only good for families and neighborhoods, but good for those who hold the loans. He argued that only "a small share of homeowners," particularly singles who have not lived in the home long, might choose to default strategically.
"It's not that moral hazard is something we shouldn't even think about or worry about at all. It's that the vast evidence shows that the vast majority of families don't operate that way," he said on the sidelines of conference on urban renewal, where he gave a speech.
The FHFA's DeMarco is considering whether financial incentives offered by the U.S. Treasury would soften concerns that principal write-downs would increase the losses at Fannie and Freddie, and in turn require the two to draw more taxpayer funding.
He has said the program would help only about 1 million borrowers, and emphasized that one major aspect still under consideration was how such a program might encourage borrowers to default strategically to obtain aid, driving up the cost.
(Additional reporting by Margaret Chadbourn in Washington; Editing by Dan Grebler)