10/20/2011 11:44 am ET | Updated Dec 20, 2011

Message to Mortgage Banks and the Feds: It's Time to Take the Haircut

The "moral hazard" is worse than you feared: Americans are figuring out that morality changes as society changes, and that morality no longer includes obediently paying the mortgage. So do you want to take your haircut by mortgage principal reductions -- or foreclosures?

That is, are you ready to deal with homeowners -- or do you want your haircut with your heads plucked one hair at a time? Because principal reductions are the only realistic way left to prevent a flood of strategic defaults and foreclosures.

Converging with the changing views of morality are hard economic facts:

  • The jobs have not come back.
  • The last of the unemployment benefits have run out for most of those laid off.
  • Many families' savings continue to shrink towards zero.

So principal reductions are also the only way to prevent a flood of situational defaults -- those caused by circumstances rather than the homeowner's choice.

Mortgage banks and federal agencies that fail to see the flood coming will then own the foreclosed homes, notably for those bank-held mortages in:

  • Bank of America's portfolio that came with the purchase of Countrywide Mortgage.
  • Chase's package of mortgages that came along with its acquisition of Washington Mutual (WAMU).
  • One West Bank, which acquired paper when it bought IndyMac Bank in Southern California from the FDIC.
  • US Bank, which acquired paper when it bought Downey Savings in Southern California from the FDIC.
  • Wells Fargo's portfolio of in-house mortgages acquired with the purchase of Wachovia bank.

And of course Fannie Mae and Freddie Mac -- you're sitting on a lot of paper too, aren't you?

Lending banks which have long since flipped the mortgages into CDOs and sold them off may feel they are now comfortably outside the game, and can rest content with their new role as "servicers," picking up some decent change on the bookkeeping work of mortgage payment processing, and then -- when the homeowner finally bails out -- a nice piece of change on the foreclosure proceedings.

But then what? You're out of the servicing business too. Maybe -- if you can figure out who owns the homes, assuming you can unravel the paper trail -- you might want to "reach out" to the investors, and see if they want to do a principal reduction. (You might pick up some change on the principal reduction, and then be right back in the servicer business.)

Otherwise what do you have to look forward to? A nation studded with abandoned, decaying houses? In a few years, even if the jobs are back, these will be mold-choked termite-ridden hulks, not worth rehabbing, and only fit for the bulldozers. There are neither mortgage payments nor servicing fees coming from bulldozed houses -- nor will there be any principal at all left in them.

"The Accelerating Shift in Attitudes Towards Home Walkaways" on 9/22/2011 in the Huffington Post provides lead-up information to this article.Walk Away From Debt for a Better Future

by Nicholas Carroll