Realty Check

Principal Forgiveness:  And Now We All Pay


The government is officially giving borrowers back home equity. Yep, somewhere between $35 and $50 billion worth. Of course we've all lost over $5 trillion, but who's counting? Lenders still aren't required to do it, but they're going to get an awful lot of taxpayer-funded incentives to do it.

I spent the morning in a briefing room FHA Commissioner David Stevens, Asst. Treasury Secretary for Financial Institutions Michael Barr, Deputy NEC Director Diana Farrell and Asst. Treasury Secretary Herb Allison (formerly of Fannie Mae ).  It was quite a panel, as they all sat there admitting that the Treasury's $75 billion mortgage bailout, after a year, was still not doing the trick.

Michael Barr: We could have certainly done better. Adjustment in the face of knowledge and learning is a good thing (he's a professor in real life, by the way. Big shock).

Herb Allison: The nature of this housing crisis has changed over the past year.

David Stevens: There has been a clear misalignment of incentives to bring together all the participants in this process.

Okay, so we're going to fix all of that now with new incentives that get the second lien holders back in the game, get investors seeing green again, and help unemployed and underwater borrowers. But wait, they all admit, this isn't going to help everyone. We're back to that hope of 3-4 million borrowers, but again, that would be a hope, or maybe an offer or maybe an estimate. You get the idea.

Still, it's bold. It's principal write down, plain and simple. Again, not a required principal write down, but a requirement for servicers participating in HAMP to consider it first as part of the waterfall involved in making loan modifications. Barr claims that when considered against interest reduction, in many cases servicers will opt for principal write down.

Let's face it, the underwater issue (that is borrowers owing more on their loans than their homes are worth) is now far bigger than the subprime issue and the unemployment issue.  Yes, it's concentrated heavily in five states, but it still manages to plague home prices nationwide.  People are walking away in greater numbers than ever before, and people who want to stay are unable to get into modification programs because of their overwhelming negative equity.

Yesterday, before the House Oversight Committee, Herb Allison said his concern with principal write down was 1) expense, 2) fairness, and 3) moral hazard. I asked him this morning what had changed overnight?

"The moral hazard aspects are mitigated by the structure of the programs."

I'm not entirely sure what that means, although I'm sure many many smart people behind closed White House doors came up with that exact phrase. I guess it means that because borrowers and servicers have to earn the write down incentives over three years that it's fair.  Or maybe because it helps keeps borrowers out of foreclosure, thereby stabilizing home prices around them, that it's fair. Or maybe because the servicers and investors have to bear some cost, that it's fair. Maybe it's just that there is simply no other way to get ourselves out from under this mess than to forget all the bad choices some lenders and borrowers made and give them a fresh start. And for those of us who acted responsibly? No pain no gain. 

As I tell my kids every day, life isn't fair.

Questions?  Comments?