WASHINGTON — A key federal regulator has rejected a push by the Obama administration to reduce the mortgage debt of millions of distressed homeowners. It’s a setback for the White House, which wants to reduce foreclosures to help the economic recovery.

Edward DeMarco, acting director of the Federal Housing Finance Agency, said Tuesday that allowing up to 2.6 million borrowers who owe more than their houses are worth to have their mortgage principal reduced would end up costing taxpayers money and could encourage additional defaults.

Fannie Mae and Freddie Mac, the housing finance giants seized by the government in 2008, own or back about 60% of the nation’s mortgages. And although many banks are reducing mortgage principal for some delinquent borrowers, they are prohibited from taking that step with Fannie and Freddie loans.

“We continue to share with everyone in government the goal of providing good opportunities to assist troubled borrowers, while protecting taxpayers,” DeMarco told reporters Tuesday in announcing his decision after months of review. “The choices we’ve had to make are hard, but they need to be made.”


But critics countered that a lengthy new analysis used by DeMarco to justify that decision showed that a large-scale principal reduction program actually would benefit taxpayers while helping reduce foreclosures.

“I think he’s trying to cook the books,” said Rep. Zoe Lofgren (D-San Jose), who has led an effort by California’s House Democrats to get DeMarco to approve principal reductions for Fannie and Freddie.

Lofgren said DeMarco’s refusal to allow principal reductions is unpatriotic and called for President Obama to replace him.

DeMarco released the findings after the administration had asked him to reconsider his opposition to principal reductions in light of new Treasury Department financial incentives to offset some of the costs.


But DeMarco said that even with the new incentives, the potential reductions in foreclosures did not outweigh the risk to taxpayers, who are on the hook for about $142 billion in the rescue of Fannie and Freddie, which are now owned by the government after they nearly went bankrupt. In many of the models the agency ran, the cost of the incentives — part of the $700-billion bailout fund — offset much, if not all, of the potential gains Fannie and Freddie would see from mortgages kept out of foreclosure.

DeMarco said he hoped that the 33 pages of analysis of potential principal reductions on the finances of Fannie and Freddie — and taxpayers, more broadly — would show that the agency is trying to do its job to protect the government’s investment in the companies. But the analysis only flared the debate as critics pointed to the agency’s own figures to show that Fannie and Freddie, as well as taxpayers, would come out ahead in some scenarios if the companies were allowed to participate in the administration’s principal reduction program.

In one case, Fannie and Freddie would see a net savings of $3.6 billion in a program that would result in principal reductions for about 497,000 underwater homeowners. Even when taking into account the $2.7 billion in government incentives, taxpayers would come out nearly $1 billion ahead, the analysis showed.

“It is incomprehensible that Mr. DeMarco would reject the chance to save up to a billion dollars in taxpayer funds while helping nearly half a million homeowners stay in their homes,” said Rep. Elijah Cummings (D-Md.).


Treasury Secretary Timothy F. Geithner said that DeMarco used “selective numbers” in justifying his decision and asked him to reconsider.

“Five years into the housing crisis, millions of homeowners are still struggling to stay in their homes and the legacy of the crisis continues to weigh on the market,” Geithner wrote to DeMarco on Tuesday. “You have the power to help more struggling homeowners and help heal the remaining damage from the housing crisis.”

DeMarco said that the scenario that showed a $3.6-billion benefit to Fannie and Freddie assumed that all 497,000 homeowners eligible for the reductions would receive them, which was unrealistic.

Excluding homeowners who had not made a mortgage payment for a year or more, the benefit to Fannie and Freddie would be reduced to $1.9 billion. After subtracting the cost to taxpayers of more than $1.7 billion in Treasury subsidies for principal reductions, the net benefit would be only about $100 million.


And that figure did not account for the potential that some underwater homeowners who are making their payments might decide to stop so they could get the size of their loan reduced.

The FHFA analysis said that it would take just 3,000 to 19,000 such borrowers to offset any potential positives to the bottom line of Fannie and Freddie from principal reductions in the 19 different scenarios modeled.

DeMarco said it was his job to consider not just the effect on Fannie and Freddie of a principal reduction program, but the additional costs to taxpayers of the Treasury subsidies.

Several leading congressional Republicans supported his decision.


“The administration put incredible political pressure on Director DeMarco, and he deserves praise for standing up for the best interests of the American people,” said House Financial Services Committee Chairman Spencer Bachus (R-Ala.).

With the housing market showing signs of improvement in recent months and the foreclosure crisis easing in California and across the country, there is less pressure on the agency to allow Fannie and Freddie to participate in the administration’s principal reduction program, housing experts said.

“The case is less compelling than it was six months or a year ago,” said Stuart Gabriel, director of UCLA’s Ziman Center for Real Estate. Still, principal reductions would be a big help in hard-hit areas such as Riverside and San Bernardino counties, he said.

Richard Green, director of the USC Lusk Center for Real Estate, said that DeMarco’s decision meant that, “for the places that really are in the most trouble, recovery’s going to take a lot longer.”


So far, Fannie and Freddie have been allowed to participate only in small-scale principal reduction programs in California and other foreclosure-riddled states.

DeMarco said those programs were not a risk to taxpayers because the companies received full compensation for the principal forgiven and the small size and screening procedures made it unlikely borrowers would try to intentionally default to get their loan reduced.

Fannie and Freddie have other foreclosure prevention programs and have helped about 2.3 million homeowners through those initiatives, which include reduced monthly payments.

jim.puzzanghera@latimes.com