Forgive Debt and Save the Housing Market

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By Mark Whitehouse

The evidence is growing: Mortgage-debt forgiveness is good for borrowers and lenders alike.

The editors at Bloomberg View have long argued that mere reductions in interest payments won’t do much to mitigate the biggest threat to the housing market: millions of borrowers who owe more on their mortgages than their homes are worth, and are hence prime candidates for foreclosure. The best way to prevent a flood of distressed properties from hitting the market is to forgive large parts of the loan balances. The strategy restores borrowers' equity, giving them a reason to maintain the homes. Lenders gain by avoiding costly foreclosure proceedings, which tend to leave them holding properties worth only pennies on the dollar.

Gradually, banks and private investors are coming around. In a new research report, analysts at Amherst Securities Group write that nearly 40 percent of all private-label mortgage modifications in 2012 provided some principal relief, up from less than 30 percent in 2011 and about 10 percent in 2010. More importantly, those loans are performing very well: Only about 12 percent of principal modifications made in 2011 have gone back into default, compared to 23 percent for interest-rate modifications and 30 percent for modifications that provide neither principal nor interest-rate relief.

Principal reductions beat out interest-rate modifications even when the two methods reduced monthly payments by an identical amount -- a testament to the importance of giving people equity in their homes.

Unfortunately, the encouraging numbers reflect only so-called non-agency mortgages -- loans not guaranteed by government-backed companies Fannie Mae and Freddie Mac, which dominate the market. Federal Housing Finance Agency chief Edward DeMarco, who oversees Fannie and Freddie, has so far steered clear of principal reductions on the grounds that they would be too costly for the taxpayers who bailed out the mortgage giants.

Judging from the data, it's time DeMarco reconsidered. Debt forgiveness would help the housing market recover, reduce losses in the longer term and go a long way toward removing one of the biggest burdens weighing on the broader economy.

(Mark Whitehouse is a member of the Bloomberg View editorial board.)

-0- Jun/20/2012 15:28 GMT