04/30/2012 10:56 am ET Updated Aug 01, 2012

IMF Lends Support to Loan Modifications Including Principal Reductions

In response to the housing crisis, some banks and private lenders are voluntarily reducing mortgage principals to assist homeowners who are at risk of losing their home. This move has recently received support from the International Monetary Fund. Managing director of the IMF Christine Lagarde has declared the housing problem in the United States as a "matter of urgency."

Lagarde's statement was presented at the Brookings Institution in Washington D.C. when she was addressing the restructuring of debt in answer to the global financial crisis. Noting that the economic woes of the United States impact other countries and the global economy, she called upon Fannie Mae and Freddie Mac, two major holdouts who have yet to endorse principal reductions, to join other major lenders in curbing the housing crisis by reducing mortgage principals to more accurately align them with the fair market value, resulting in fewer underwater mortgages.

Acting Head of the Federal Housing Finance Agency Edward DeMarco has been under scrutiny by the Congress, administration, and regulatory agencies for his reluctance to give the go-ahead for mortgage principal reductions. The fact that Lagarde's additional call for his approval was made prior to a meeting between the IMF, the World Bank, and finance officers from 20 countries is likely to increase that pressure.

Lagarde based her plea on the responsibility of each country to implement measures that would improve economic stability. She deemed the financial outlook in the United States to be "fragile," but with some signs of recovery, and urged legislators and agency leaders to use this as an "opportunity to push on and take the further actions that are certainly needed to keep the crisis at bay and finally put it behind us."

Principal reductions in existing mortgages will prevent homeowners from going into foreclosure by providing them with a new, modified monthly payment that they can afford. Financial institutions do take a loss, but many lenders and banks view principal reductions to be a better, less costly, alternative than foreclosure or short sales.

The IMF's public approval of mortgage reductions, as well as reform in the financial sector, is intended to provide support to the economy and reignite a healthy increase in lending, which will spur economic and job growth.

Reducing mortgage principals is one of the several steps being taken by major U.S. lenders. One reason can be attributed to revisions to the government's Home Affordable Modification Program (HAMP), which offers lenders an incentive of 18 to 63 cents for every dollar in mortgage reduction. The HAMP revisions now offer that incentive to Fannie Mae and Freddie Mac; however, neither has indicated a willingness to allow reductions in mortgage principals, favoring instead other approaches to help homeowners prevent foreclosure.

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