patrick.net

"When one of the banks CEO was questioned about why the sudden shift bank in policy, he said it was the responsible thing to do to save California."

...and then he took another bong hit and laughed maniacally, hopped into the $60,000 car he purchased with his exorbiant bonus, and headed off to his vacation home.

So the real question here is it more economically fesaible to reduce outstanding mortgage principal balance, there by encourging the mortgage holders to continue paying there mortgages instead of getting foreclosured on? The Value of houses in California have fallen about 1/3 since the peak in 2006. So lets assume that a typical house during the boom cost 600k, and it's fallen 1/3 in value, and is now worth 400k. We'll assume the outstanding balance is still 600k (zero down payment, and a mortgage that did nothing to pay down the principal) We will also make the assumption that the "owner" of the house can still afford to make the payments, but the lost in equity makes walking away very attractive. (or the can afford to make the payments at the reduced principal amount)

So lets modify his loan and give him a fixed rate 5% interest rate mortgage for 400k. This will reduce his payments, encourge him to stay and continue to pay his mortgage, in theory for the next 30 years. the bank eats 200k, but changes a trouble asset into a solid asset.
On the other hand, screw him, lets do nothing, let him suffer. He stops paying his mortgage. We send him threating letters, then foreclosure. So what happens? Well first off he continues to live in the house, and not make any payments while our foreclosure slowly works in way thru a backlogged court system for at least 1 year. In that time the market continues to deteriorate the house is worth 10% less now, at 270k, by the time we foreclouse and get the deadbeat out of the house. Being a spitful owner, he trashes the place, holes in the walls, etc, 30k in damage, house value reduced to 240k now, it costs us 50k to foreclouse, and to evict them another $1k and a couple more months. Total value of the house 240k minus costs 51k = 189k. Now we can list the house at the highest price can can, cuase we don't want to lose too much money on the place, or course in the condition it's in, no one touches it. So now we either reduce the house to firesale prices, or invest 30 or 40k of our own $ into it to fix it up and get it into move in condition so regualr buyers will at least consider it. Another 6 months lost doing repairs, sitting on the market, we have a buyer, sold at 255k. (270k market value after investing 30k in repairs and another 5% in deteriorating market value reduction). 500k original mortgage + 81k in costs = 581k - 270k = 311k in the hole.
331k vs 200k? Modifying looks like the most effective way to minimize costs.
However there is a potential down side to this whole process. The assumption is the mortgage holder will be satified with the principal reduction and continue to pay his mortgage. But what if the market continues to deteriorate and his house is now only worth 350k and his mortgage is 400k, isn't his god given right to have equity in his house, is he going to want another principal modification a year or two down the road?

@ Tech

Clearly, you are right that it makes more financial sense to reduce the principal on the loans. I wonder if the reluctance is due to the accounting shenanigans that banks are allowed to play right now. If they reduce the principal, then I imgaine that they have to take the $200K hit immediately, whereas they can hold the non-performing loan on the books at full value (for now).

It is a very slipery slope when and if Banks were to ever reduce a principle balance on a first mortgage. Once you start a policy like that everyone that has a mortgage would want to have their principle reduced too. That's why it never going to happen unless Banks are forced to by law or by a Bankruptcy judge.

In a chapter 13 proceeding, a house owner is allowed to completely discharge a 2nd mortgage balance if the value of the house puts that 2nd mortgage underwater. The 1st mortgage balance can not be touched in a chapter 13 proceeding; either the borrower pays 1st current in the plan or the borrower has to surrender the property.

I hope and pray I can document 1 (one) load principal reduction of any kind. My plan would be to immediately file a class-action suit and have at all of them with all mortgage holders, deadbeats or not demanding a like-kind opportunity to reduce their principal.

Please God, Please. Just 1.