'Stategic' Defaulters May Face Heat

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NEW YORK (TheStreet) -- The Inspector General of the Federal Housing Finance Agency believes Fannie Mae(FNMA) and Freddie Mac(FMCC) would benefit if they more aggressively pursued borrowers who default on their mortgages despite having an ability to pay.

"If the Enterprises can recover mortgage deficiencies, then they can mitigate some of their losses," the Office of Inspector General said in a report Tuesday. "For example, with respect to borrowers who may currently or in the future possess the ability to repay--such as, but not limited to, owners of investment properties or vacation homes who have defaulted for strategic reasons--pursuing deficiency collections and judgments may provide an added source of revenue for the Enterprises."

The pursuit against such borrowers "may deter others who are considering default despite being financially able to make their mortgage payments," the report added.

When borrowers default, the properties are foreclosed upon and sold. But the sale price might sometimes not be enough to make the lender financially whole. The shortage or loss is called a deficiency.

The lender could either absorb the loss or depending upon state laws on recourse, try and recover the deficiency from the borrower.

But the agencies efforts to recover these deficiencies have come up short, the report found. In 2011, the enterprises recovered only a small fraction of the deficiencies they pursued--approximately $4.7 million collected out of $2.1 billion pursued, according to the report.

Part of the problem was because the agencies lacked any guidelines on how to recover deficiencies. Fannie and Freddie differ on how they pursue deficiencies, with the former seemingly the more aggressive in their approach.

For example, Freddie Mac delegates the decision to its vendors, but Fannie Mae maintains oversight of its vendors' decision-making methodologies.

Also, Freddie Mac does not pursue deficiencies when third parties are the buyers at a foreclosure sale but Fannie Mae pursues deficiencies regardless of whether it or a third party is the purchaser at a foreclosure sale, the report found.

The Inspector General called upon the FHFA to enhance its oversight of the enterprises deficiency management process.

"The Agency should obtain information to better understand the Enterprises' deficiency management processes and assess whether further improvements are needed to ensure the Enterprises are efficiently and effectively managing their credit loss mitigation activities."

The FHFA-OIG, however, cautioned that its recommendations for enhancing the Agency's oversight of the Enterprises' deficiency management processes "should not be construed as encouragement to aggressively pursue borrowers who do not have the ability to pay their mortgages."

-- Written by Shanthi Bharatwaj in New York.