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Stemming the Foreclosure Crisis: Principal reduction plus shared equity

By Nandinee Kutty  Posted by Nandinee Kutty (about the submitter)     Permalink
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March 5th, 2008 marked a quantum jump in the response of U.S. federal authorities to the foreclosure crisis facing America. Fed Chair Ben Bernanke urged bankers in Orlando, Florida to reduce the principal amounts of their mortgage loans to distressed homeowners.

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Lenders anywhere in the world usually balk at debt forgiveness, or partial debt forgiveness, and U.S. mortgage lenders are no different.  Some have made polite noises showing some accommodation towards this suggestion, as long as it is voluntary for lenders to act upon it. But one bond investor minced no words and described the proposal as pouring napalm on the fire. 

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The Administration’s response to the foreclosure crisis has taken the form of the “Hope Now” program and other similar programs, endorsed by Treasury Secretary Paulson and President Bush, which seek mortgage servicers to voluntarily reset mortgage rates to lower levels than previously decided, or to freeze the reset for a period of time.

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But now federal regulators, members of Congress, and advocacy groups are ratcheting up the pressure and talking about a “vigorous response.” According to Sheila Barr, Chair of the Federal Deposit Insurance Corporation (FDIC), current efforts are analogous to “kicking the can down the road.”

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Bernanke seemed to acknowledge the limitations of current programs when he exhorted:  “more can, and should, be done.”

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Although Tuesday was the first time that the Fed Chair used his bully pulpit to urge lenders to mark down principals of their home loans, in the recent past federal officials have made similar proposals.

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FDIC Chair Sheila Bair said last month that lenders should be more aggressive about writing down principal; and the Office of Thrift Supervision Director John Reich proposed a plan for principal reductions accompanied with loan servicers getting certificates that can be redeemed if home values rise by the time the property is sold.

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What has prompted the quantum jump in proposed policy responses is the fact that a startling number of U.S. homeowners—8.8 million—now have negative equity in their homes—that is, the value of their mortgage loan exceeds the market value of their home. And this number is projected to grow to still more alarming levels, peaking to nearly 14 million in the second quarter of 2009, according to Moody's Economy.com.

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