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Thursday, January 7, 2010

Mortgage Loan Principal Reductions and Rewarding Responsible Behavior

The insanity over trying to keep 'underwater' homeowners in their homes is growing.   See the latest prominent article from Bloomberg News.    I have a much different solution to this "crisis."  As Crime, Politics and Policy has said before (including earlier this month), reducing the mortgage principal for some homeowners to create new "equity" is the equivalent of giving these owners a check for the amount of the reduction.  It is an underwater-homeowner bailout, pure and simple.   The problem is that the bailout of this select class -- many of whom knowingly assumed outsized risks which many other would-be homeowners were not willing to do -- will benefit those who took risks, at the expense of others who did not take any risks.

This is a moral hazard.   Many people wanted to buy homes and were "priced out" during the post-9/11 price bubble.   These would-be buyers often lost out on bidding wars, time and time again, because they were unwilling to stretch beyond their means for a house and lost out to the ultimate purchasers, many of whom intentionally threw caution to the wind with the riskiest mortgages they could get in order to minimize their down payment and/or monthly payment.   Now the responsible "losers" in the 2002-07 bidding wars, the ones who refused to take negative amortization or one-year adjustable rate mortgages because they recognized the downside risk and (very rightfully) were uncomfortable, may lose out a second time to this select class of "victims."

I have a fair proposal.   Allow all homeowners to qualify for a home loan principal reduction.   I propose that the homeowner be allowed a one-time reduction of double (or triple) the amount of a one-shot lump sum payment.   This would give a homeowner who pays $25,000 a $50,000 principal reduction.  The bank suffers a current writeoff and its future cash flow from mortgage payments will be reduced, but its balance sheet pain is offset by an immediate and significant -- and very real -- cash infusion.  Unlike TARP, this money would not have to be paid back to the government.   Talk about helping banks' liquidity, especially when there's a credit crunch.

I believe this principal reduction plan should be implemented anyway, both to give real relief to banks (without pounding the taxpayer) and to reward responsible homeowners at a time when popular faith in playing by the rules seems to be at an all-time low.   It is important to reaffirm the sense of fairness and equality in our society.   Otherwise, the crime waves of tomorrow, engaged in by people who may claim a degree of moral righteousness (think Robin Hood), may dwarf anything we've ever seen.   This is how we keep 21st Century America from devolving into 20th Century South America.

 Eric Dixon is a New York lawyer who has been practicing law since graduating from Yale Law School in 1994. Mr. Dixon cautions that this article is not legal advice. Mr. Dixon has handled election law and other matters for over two dozen political clients, and also handles corporate investigations, due diligence and sensitive matters including crisis management.  Mr. Dixon is available for consultation or comment at and 917-696-2442.

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