(Source: OC Housing News) – Ever since the Great Housing Bubble began to deflate, everyone incorrectly identified foreclosure as a problem because foreclosure pushes people out of the house the bank bought for them. The real problem is not foreclosure; the real problem is that borrowers have excessive debts due to the huge loans lenders underwrote that inflated the housing bubble. Foreclosure is not the problem, it is the cure.
Principal reductions are the worst possible solution to the problem of excess debt left over from the Great Housing Bubble. Principal reductions merely gives foolish borrowers a pass. If the borrowers go through foreclosure, they have consequences that minimize moral hazard:
Borrowers will be forced to rent, at least for a time.
Borrowers will have reduced access to consumer credit as the foreclosure lowers their FICO score.
Borrowers will have to save and be prudent in order to meet the standards of home ownership and get another loan.
How could anyone selectively forgive principal and achieve fairness to all borrowers? What message does principal forgiveness send to those who were foolishly prudent? Think about it: if you were prudent and paid down your mortgage, you will probably not see much if any principal reduction; however, if you were a wildly irresponsible HELOC abuser, you will see significant principal reduction which will merely enable more HELOC abuse later.
Principal reductions will serve as a major incentive for reckless borrowing. Everyone knows if enough people take the money and behave stupidly that everyone will get bailed out.
Foreclosure balances the equation. There must be some consequences to borrowers for their behavior, not because it is immoral, but because what you don’t punish, you encourage. We can’t afford to privatize gains and collectivize losses or we will go broke as a country. We are not a banana republic, but principal reduction without consequence is certainly a path that leads us there.