States Test Mortgage Principal Write-Downs

Financial institutions have grudgingly modified mortgages for thousands of distressed homeowners by lowering interest rates, spreading principal repayments over more months, even forgiving some overdue interest. They've tried almost anything—except lowering the total amount owed.

Just 4 percent of loan modifications involved a principal reduction in the third quarter of 2010, according to the U.S. Office of the Comptroller of the Currency. Mark Zandi, chief economist at Moody's Analytics (MCO), says that negative equity, owing more than a home's value, is the biggest long-term obstacle to a rebound. Principal write-downs "would be very helpful in stemming the ongoing foreclosure crisis," he says.