Mortgage Principal Reductions Back in Focus (Update 1)

Updated from 10:36 a.m. ET with a statement from Attorney General Eric Schneiderman.

NEW YORK ( TheStreet) -- President Obama is expected to nominate a new director for the Federal Housing Finance Agency on Wednesday, a move that consumer advocates hope will pave the way for greater mortgage relief to borrowers.

Rep. Mel Watt (D-N.C) -- a member of the House Financial Services Committee -- has been picked to run the regulator of government-sponsored enterprises Fannie Mae ( FNMA)and Freddie Mac ( FMCC), according to various press reports.

Watt has previously pushed for changes in mortgage lending practices and for improving access to credit for low income and minority borrowers.

Significantly, Watt has been supportive of principal reductions, a contentious form of mortgage relief that has been stiffly opposed by the FHFA's current acting director Edward DeMarco.

The appointment, if confirmed, could pave the way for principal reductions by the GSEs, though it is likely to be contested by Senate Republicans.

Advocates of principal reduction believe it is the most effective form of mortgage relief for deeply underwater borrowers, as it not only lowers the monthly payment but also restores more equity in the home and reduces the likelihood that the borrower will walk away from their mortgage.

A study by Amherst Securities analyst Laurie Goodman last year showed that principal reductions result in the lowest default rate among mortgage assistance options. For 2011 modifications, for example, the re-default rate after 12 months for principal modifications was 12 percent, compared to 23 percent for rate modifications and 30 percent for capitalization modifications, according to the report.

The FHFA's DeMarco, however, has resisted pressure from the Administration to reduce principal on mortgages, arguing that the program would be too costly for taxpayers, complicated to administer and would encourage strategic defaults by borrowers hoping to take advantage of the program.

Since the GSEs account for nearly 60% of the country's mortgages, relatively few borrowers have been able to benefit from this form of relief.

Liberal activists who have been calling for DeMarco to be replaced on Wednesday applauded the decision to appoint Watt.

The appointment is a "victory for American homeowners, taxpayers, and our economic recovery," according to Alan Jenkins, Executive Director of The Opportunity Agenda. "We congratulate President Obama on this important move, and call on the U.S. Senate to quickly consider Congressman Watt's nomination. Swiftly replacing DeMarco with a Home Opportunity Hero like Mel Watt will uphold our national values of opportunity and fairness while speeding our economic recovery."

Policy analysts have, however, expressed doubts that Watt or other candidates will win confirmation in the Senate. "Senate Republicans (who have the votes to block a nomination) will be extremely reluctant to support a candidate who has publicly backed principal reductions, has supported bankruptcy changes allowing for "cram-down" on residential mortgages, and served on the House Financial Services Committee during the height of power of Fannie and Freddie (having accepted campaign contributions from both)," FBR analyst Edward Mills wrote in a report when rumors of the appointment first surfaced in March.

"We also anticipate concern that Congressman Watt may not meet statutory requirements for the director's position," Mills wrote. "Should other candidates emerge, we anticipate they would face similarly long odds in the Senate."

New York Attorney General Eric Schneiderman, a harsh critic of DeMarco, said in a statement that the move was a "good first step" but added that "struggling homeowners cannot afford to wait for the Senate to complete the confirmation process."

He said Obama should use his legal authority to appoint a new acting director in the interim.

-- Written by Shanthi Bharatwaj in New York.

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