Amherst's Laurie Goodman argues: "Across all product types, the loans with higher mark-to-market CLTVs (combined loan to value) transition to default at a much higher rate than do loans with lower mark-to-market CLTVs."
So the more equity you have in your home, the less likely you are to default on your loan.
She also shows that the re-default rate on modifications with principal reduction is the lowest of all types of loan modifications.
But what about the slippery slope? The moral hazard??
"First, the current modification program already has a moral hazard issue; borrowers are clearly defaulting to get a rate reduction.
Second, we can introduce a series of frictions [she suggests some interesting taxes, credit hits and additional costs] so borrowers who need the principal reduction are able to obtain it, and those who don’t need principal reduction are not envious of those who receive it.
Third, the moral hazard problem only extends to underwater borrowers, of which there are a finite amount, and the overhang can be sized."
A couple of things have become abundantly clear since Iowa AG Miller put out his proposal, first and foremost that any settlement is going to be divisive and complicated and may not even come from a cohesive group but instead in bits and pieces from different agencies. It very well may force some principal write down, but I doubt it will be so large as to cripple the big banks, who have already taken massive losses on troubled loans.
Principal write down is a slippery slope and a moral hazard, no matter how you argue its merits.
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