Fannie Mae And Freddie Mac: What Is An Underwater Mortgage?

The problem is fairly simple. About 11 million home mortgages in the US are underwater. These homeowners owe more for their homes than their homes are worth. That has had several effects. The first is that the equity Americans used to be able to tap with their houses as collateral has almost disappeared. They cannot rely on the value of what was once their major asset. That leaves the costs of expensive goods, retirement, and educations squarely on the shoulders of working Americans.

Another significant issue is that people who believe they will never be able to pay their mortgages because the value of their homes will never rise are more likely to default on their loans than those with equity. This is particularly true for people who lose their jobs or are deeply in debt. Underwater mortgages create gridlock in the housing market by keeping some homes from being sold and others on a path to foreclosure.

The Administration and some members of Congress have been furiously at work to fix the national mortgage problem. The economy, they say, cannot  recover if the housing market continues in free fall.

The latest idea to salvage the market is to get Fannie Mae and Freddie Mac to modify home loans. They own or service over half of the mortgages in the US, which puts them in a unique position to solve the trouble. A number of media claim the Federal Housing Administration wants the two firms to join programs to reduce the principal owed by homeowners so that they have some equity in their houses.

The idea faces several hurdles. The first is that taxpayers have put several hundred billion dollars into Freddie Mac and Fannie Mae to cover losses from bad home loans and mortgage derivatives. The two agencies might be able to take on a modification program for underwater mortgages, but there is a cost for lowering hundreds of thousand of mortgages. The difference between current loan values and modified balances must be made up somewhere. Banks cannot be asked to take on the task. Some financial institutions could not afford the cost even if they wanted to.

The other problem is deciding which of the millions of underwater mortgages should be modified. Is the benchmark a mortgage that is 10% short of the value of the home? Of, is it 20%? Who will appraise the homes to set values in a real estate market in violent flux? What will the appeal system be for homeowners who believe that they  were treated unfairly?

The salvation of the financial fortunes of millions of homeowners is noble, but it is not a job the federal government can do.

Douglas A. McIntyre