Writing down the principal on mortgages

It's obvious that the economy still isn't doing well.  Furthermore the rate of foreclosures won't peak until the end of 2010.  On top of that, most observers agree that the Obama mortgage modification plan has been a failure.

That all said, I'm surprised that so few commentators have leapt on the "we should write off some of the principal" bandwagon.  It's not currently a bandwagon at all.

I know that a) this idea is WRONG, b) it is terrible for the long run rule of law, and c) it is EVIL and UNFAIR.  It's also one of the few suggested economic remedies that might have worked or maybe could still work. 

How so?  It limits value-destroying foreclosures.  It gives homeowners the right marginal incentive to keep on making payments and maintain the value of the home and to maintain their credit capabilities.  It gives the housing market a fresh start rather than this waiting/coordination game where we wait for everyone to move on down a notch in house quality, thereby freezing parts of the housing market and choking off required recalculations.  (How can you have a well-functioning housing market when so many people have negative equity?  I've read estimates of twenty percent of the U.S. population.)  It also limits the problem of future ARM resets, once interest rates rise in the future.

It's all about long-run vs. short-run and I usually side with the long run.  But the short run modification of property rights has so many defenders in other contexts, so why not here?  Call it "clearing up financial logjams" if you wish.

Is it a better marginal incentive than suddenly increasing the taxes on banks?

Bernanke himself once suggested the idea.

I might add that by fostering an actual recovery, writing off the principal on mortgage loans might limit some of the other bad interventions that we will try or have ended up trying.  There's more than one way to toss away the rule of law.