Rather Than Push For Mortgage Principal Reductions, Treasury Hopes Servicers ‘Do It On Their Own’

One of the major problems with the Obama administration’s foreclosure prevention efforts has been that it does not include a mechanism for reducing principle (the total amount owed) for mortgages that are underwater (where the outstanding mortgage balance is greater than the worth of the house). Part of this is due to the demise of mortgage cram-downs, which the banking industry has managed to defeat time and time again in the last few years.

But according to senior Treasury Department adviser Seth Wheeler, the administration hasn’t been pushing for principle reductions because it’s been hoping that mortgage servicers would implement them voluntarily:

“When the administration came into office last year, from the get-go, it has certainly been aware of the link between negative equity and challenges in housing,” said Wheeler. “As the administration initially designed the modification program last year, it was aware of negative equity, was aware that some servicers were doing principal reductions”…So for the past year, the administration had a policy of “rather than us endorsing a uniform approach to principal reductions, let’s give flexibility to servicers and hope that they do it on their own in the right circumstances,” Wheeler said.

One big problem with the mortgage modification portion of the administration plan (which does not address underwater mortgages) is that it relied too much on voluntary servicer action. It’s unfortunate to see the administration acknowledging that it had the same expectation when it came to principle reduction.


Currently, about one in four homeowners is underwater, which amounts to 10.7 million households. By June, a staggering 5.1 million borrowers are projected have home value’s that are below 75 percent of their outstanding mortgage balances, which new research suggests is the point when “the owner starts to think hard about walking away, even if he or she has the money to keep paying.”

“Negative equity is the single most important driver of defaults,” said Laurie S. Goodman, senior managing director at Amherst Securities. “If the other measures in [the Home Affordable Modification Program] aren’t working, the government will have to look at principal reductions,” added Brian Bethune, chief financial economist at IHS Global Insight.

While the administration is reportedly examining ways in which to incentivize principal reductions, the assistant Treasury secretary for financial stability, Herbert Allison Jr., said in a recent briefing that “we haven’t yet found a way of dealing with this that would, we think, be practical on a large scale.” But as I pointed out last month, not only is finding a way to reduce principal good economically, but it is good politically, as it will show that the administration is willing to go toe-to-toe with the banks in order to keep homeowners in their homes. So it would behoove Treasury to find a way to make this work.