by Calculated Risk on 1/18/2010 08:46:00 AM

A couple of quotes from an article by James Hagerty in the WSJ: Is Slashing Mortgage Principal the Answer?

... Assistant Treasury Secretary Michael Barr ... suggested that there would be a risk that such a [principal] program would change a lot of borrowers’ behavior. “Most people, most of the time, make their mortgage payments ... even if they’re underwater,” Mr. Barr noted. “You have to be quite careful not to design a program that induces more people to walk away” ...

This is a major concern. A couple weeks ago I wrote: New Research on Mortgage Modifications and Principal Reduction

Imagine what would happen to Wells Fargo or Bank of America if their borrowers found out that the banks would substantially reduce their principal if they were 1) underwater (negative equity), and 2) stopped making their payments. The delinquency rate and losses would skyrocket!

Because of this risk, a macro principal reduction program is very unlikely.

And another quote from the WSJ:

Tom Capasse, a principal at Waterfall Asset Management LLC, a New York-based investor in mortgages, says it’s too late to prevent a “seismic shift” in borrower behavior ... “There used to be a scarlet D on your forehead if you defaulted,” says Mr. Capasse. “Now it’s a badge of honor.”

Not quite a "badge of honor", but the widespread acceptance of "walking away" has been one of the greatest fears of lenders for some time.