Can you carry your home on your back underwater? A year ago I advised US officials (unnamed) that they should look at 15-25% writedowns of mortgage debt for obviously distressed borrowers by the banks, and Federal agencies Fannie Mae and Freddy Mac etc. to be supervised by FDIC whose responsibility is the solvency of the banks. In the absence of this, banks were having to take write-downs on their p/l and capital reserves and then sell the collateralized debt at larger discounts to vulture fund investors - which became the TARF scheme. 
In a country where keys may be handed in and borrowers face no further redress, the risk of defaults and 'key drops' is very high when borrowers find themselves in severe negative equity i.e. where the principal to be repaid is worth more than the market value of the property and is unlikely to become positive in say the next 3 years. My argument (alongside that of using TARP for 'insurance' purposes, of which various schemes also including Bank of England's SLS and APS are versions) was that providing liquidity and capital support only to the banks directly risks providing help at the wrong end of the economy's food chain - and is what was wrong with Japan's response to the property bubble burst and long term low growth of the 1990s. japan consumers found themselves drowned in multi-generational property debt just to live in troglodyte holes.
I suggested it could be more efficient and economically lower losses all-round, for several million mortgages to have their principals discounted - at a rate substantially less than how much CDOs (RMBS, securitized retail mortgage assets)are being discounted/devalued. It now looks as if the US Treasury Department, or at least FDIC, is going to help homeowners who owe more than their homes are worth? They are at least thinking about it. Yesterday, a US Treasury official hinted the department is moving to write down mortgage principal. Congressional legislators, arguing the interest of 'main Street', economics analysts such as myself, commentators and consumer interest groups have called many times over many months for such a shift in policy focus. Then, according to Huffpost, Treasury spokesman Andrew Wiliams e-mailed to say, "Treasury is NOT poised to roll out a major principal write-down program. As the [official] said, we are looking at a number of tweaks to existing programs to help reach more borrowers." Note that 11 million mortgagees are in negative equity, a quarter of all residential mortgage borrowers - who fear they are 'paying good money after bad'.
FDIC Chairman Sheila Bair, at a housing conference on 4th March, said she is "actively looking at principal write-downs" to help homeowners get sustainable and affordable loan modifications. "We need to recognize the evolving nature of the mortgage problem...The initial phases of the crisis involved poorly structured mortgages that posed an affordability problem. Now we're dealing with underwater mortgages." 'Underwater' can now be said to have been formally elevated to a financial technical term.
Writing down principal is "one possible way to encourage borrowers to stick with their mortgages," she said. "This could help reduce defaults, keep people in their homes, avoid costly foreclosures, and enhance the value of these loans.
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