Research has clearly revealed that owing more than the value on your home is the strongest predictor of foreclosure, and housing finance analysts widely agree that principal reduction is the best medicine to avoid this outcome.
I've become involved with a Quora post about Mortgage Principal Reduction. You can see the responses here.
This is my latest response to all the latest postings:
Full disclosure: I own a home and am underwater. I am current on my mortgage, in which I owe about 140% of the current value of the home.
Moral hazard. These banks are still around even though they should have gone under in 2008. They are zombies now and will die out sooner or later. The next crisis is coming. Our crony capitalist system is 'fixed' and is not sustainable. Where is the moral hazard for these banks that gave out the NINJA loans, the liar loans, etc.? These banks make millions in fees, get saved by taxpayer money, shower themselves in bonuses, then refuse to help the very customers that they took money from ( in fees and taxes). These banks don't even know where the papers are to a lot of the mortgages (see the robo signing scandal) and are in such a hurry to save themselves that they are foreclosing on the wrong people. This question of principal reduction has become a big 'pity the poor banks' forum. Most people that have answered this question seem to be assuming that everyone will simply try to take advantage of the principal reduction for those underwater and will be greedy. I am just saying that I would like to see us figure out a way to arrest the falling of prices and stabilize the market. You could tie the write down to something so that when housing stabilizes and begins to rise again, the bank that is holding the mortgage would see some or most of the upside. The point is, you can address the moral hazard part and do the write downs. The 'wait and see' approach has not stopped housing prices from falling, so I don't think that is no longer an option.
Another question: How much of these 'toxic assets' do the banks still own? They won't say because as soon as they let that cat out, they are finished because it will be revealed that the emperor has no clothes. It's called mark-to-market accounting. The banks hate mark-to-market because they have to reflect asset value loss on their balance sheets, and that can results in lower earnings. The current value of the mortgages would reveal a lot of banks to already be insolvent. So doing a principal reduction and a refi would actually allow the banks to have a more realistic number on their books and reduce the risk of losing the whole mortgage in foreclosure or having owners do a strategic default.
Most of the answers here are assuming that the current state of banking is likely to continue for the foreseeable future. I think that is a big assumption.
This notion that the banks are hands off on the economy is odd. The banks spent the past 30 years using the national economy as a giant casino and share much of the responsibility for cratering the economy in 2008. But lets not forget that if you don't have banks, you don't have a national economy. These banks are publicly owned companies that answer to shareholders, not private partners. I would like to see the banks return to being privately owned, boring-banking, 3-6-3 institutions that we had in the middle of last century but we will have to wait for the next crisis for that scenario to increase in likelihood.
It makes absolute sense to spend on infrastructure with federal borrowing costs at historic lows. Putting that off just makes it more expensive for future generations because it has to get done. But who thinks long term in this country? Not politicians and certainly not the banks.
Cleveland is tearing down homes because they are left abandoned after the foreclosure and are then looted for anything of value. This makes them completely worthless, which further depresses the values in the surrounding neighborhood. I have never seen anything like it. The banks are supposed to sell the properties ASAP in a foreclosure even if that means taking a loss. This is something that is not happening at all in Cleveland because they apparently can't give them away and are not willing to spend thr thousands of dollars needed to fix the homes to make them sellable. Which means that the banks would rather take a total loss on the home instead of trying to keep the current owners in the house and getting some of the money back. Which to me proves that the banks can take the hit that people in this forum are saying isn't possible. This is why I don't understand why the banks are willing to take take a total loss on a home vs taking a partial loss on the home and letting the owners stay at a reduced principal and interest. The only reason this make sense is that the banks know they are in trouble, so they are just milking all they can through foreclosure fees and other fees to bleed the system dry until their day comes.
Debt forgiveness is one of the hallmarks of our society. For example, bankruptcy laws have been on the books since our country's founding, in part due to our founding fathers' disgust with European usury laws, and an understanding that extreme, unworkable debt serves no purpose but to enslave the debtor to his or her creditors. I mean, even Mitt Romney suggested at a forum in Florida on January 23. http://www.huffingtonpost.com/2012/01/23/mitt-romney-foreclosure-florida_n_1223394.html
To quote an article by Eliot Spitzer and Dylan Ratigan about this http://www.ritholtz.com/blog/2012/01/mitt-romneys-state-of-the-union-challenge-on-the-mortgage-crisis/
"If you force the banks to recognize losses on the mortgage debt they are holding, then all of a sudden they will have an incentive to write down debt. Otherwise, a bank will do anything it can to maintain the fiction that the debt is worth 100 cents on the dollar, including lie, harass, and robo-sign. "
There is even a video segment where they address this topic: http://www.dylanratigan.com/2012/01/24/eliot-spitzer-simon-johnson/
People have been screaming about inflation for years yet it's not there. Let's stop being spooked by these phantom bond vigilantes. It will take strong leadership right our economy, and I'm still looking for it. The banks made a huge number of loans based on the assumption that housing would not drop in value. It was assumed that letting the banks go under in 2008 would have been as disaster so we bailed them out and kept all the players in place and have been limping along ever since. Now the assumption is that principal reductions will lead to chaos. Could this assumption also be wrong? The only moral hazard I see is that we are allowing these gambling addicts that call themselves bankers to stay at the table.
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