A Proposal For Reducing Mortgage Defaults By Principal Reduction

This article provides some data on housing that leads to the conclusion that mortgage principal reduction is the only way to deal with our housing crisis. Currently 10 million out of 55million mortgages exceed the value of the home. This is the leading cause of mortgage defaults. Banks hate the idea of writing down the principal to reduce defaults but it may be less costly than trying to prevent defaults by reducing monthly payments by refinancing at lower interest rates. That only reduces the monthly payment. It does not reduce the number of underwater mortgages.

If one looks at supply and demand for homes, housing prices are likely to continue a downward trend. That will increase the number of mortgages that are underwater and increase the number of defaults. Demand for homes has been affected by a decrease of 20% in the number of households that qualify for mortgages using the tighter standards that are in place. New household formation is also low because of the large number of young people out of work or with low paying jobs. This leads to an estimate of 6.2 million excess home inventory. Prices will continue to fall and lead to "death spiral" in which the number of underwater mortgages continues to rise. Principal reduction is the only way to reduce growth in underwater mortgages.

This is a scary analysis. There is another factor that might contain the "death spiral". The Boston Fed studied this problem and concluded that the owners of homes that are underwater continue to make payments as long as they remain employed. Government should do whatever is necessary to stimulate job growth in order to contain mortgage defaults. As long as unemployment remains high, the death spiral will continue.