Marketplace Scratch Pad

It’s the principal of the thing

Scott Jagow Feb 4, 2010

The housing market has an enormous elephant in the room, and no one seems to be able to move it. If homeowners start walking away from their mortgages en masse, there’s little doubt the housing market will collapse and take the economy with it.

So far, banks have been unwilling to entertain the idea of reducing mortgage principal. They’re afraid of missing out on the upside when/if prices bounce back. But their resistance to principal reductions is only encouraging more of their borrowers to take a hike. From last night’s Marketplace:

South Carolina real-estate lawyer Cathy Olivetti is seeing more and more homeowners willing to walk away from their mortgages. That’s because they owe so much more than what the property is worth now.

OLIVETTI: We’ve got to start addressing principal reductions.

A new report from First American CoreLogic finds that people whose homes are worth 25 percent less than what they owe on the mortgage are much more likely to stop paying. One in 10 American homeowners will reach that point by June.

This week, a group of mortgage investors proposed a principal reduction plan, as described by Reuters:

The Mortgage Investors Coalition — which represents holders of some $100 billion in mortgage bonds — instead of demanding full write-downs on second liens are prepared to consider a principal reduction plan where losses are shared, said Micah Green, an attorney representing the group. This softened position on second liens could help break the impasse keeping big bank servicers from forgiving principal, he said.

This is one of a number of several proposals designed to encourage banks to share losses with the borrowers. The New York Times has a collection of them, including these ideas from Brent White, associate law professor at the University of Arizona:

Here’s one idea he suggested: that the government or a consumer advocacy group start a public education campaign to encourage underwater homeowners to walk if their lender is unwilling to negotiate a lower principal. And another idea: Congress should amend the Fair Credit Reporting Act to prevent lenders from reporting mortgage defaults and foreclosures to credit rating agencies. This, he said, would level the playing field and enable borrowers to more credibly threaten to walk if their principal is not reduced, possibly making lenders more willing to negotiate.

This is truly a mess. People who rail against the “walkers” say: They’re decimating home values for their neighbors. They’re abrogating a contract. They’re ruining their credit. They may be setting a bad precedent for their children.

On the other hand, companies walk away from their obligations all the time. The banks snake-oil ways helped create this disaster. If we’re talking morality on the homeowner side, how about the banks? Many believe they should help with the clean-up. From the Atlantic Wire:

Traditionally down payments are supposed to prevent this situation from arising. The larger the down payment, the more a “walker” is walking away from. But in the recent real estate bubble, banks demanded smaller and smaller down payments for larger and larger mortgages to less and less qualified buyers. They encouraged people to take second mortgages every time their house value increased. There was no gun to the head of the home buyer, but there was no gun to the head of the bank, either. It was a folie a deux. Both sides of the deal were foolish. Why shouldn’t both sides suffer when the deal goes bad?

What do you think? How should we deal with the elephant?

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