To halt the fall in house prices, the government should reduce mortgage principal when it exceeds 110 percent of the home value. About 11 million of the nearly 15 million homes that are “underwater” are in this category. If everyone eligible participated, the one-time cost would be under $350 billion. Here’s how such a policy might work:
If the bank or other mortgage holder agrees, the value of the mortgage would be reduced to 110 percent of the home value, with the government absorbing half of the cost of the reduction and the bank absorbing the other half. For the millions of underwater mortgages that are held by Fannie Mae and Freddie Mac, the government would just be paying itself. And in exchange for this reduction in principal, the borrower would have to accept that the new mortgage had full recourse — in other words, the government could go after the borrower’s other assets if he defaulted on the home. This would all be voluntary.
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