Government and private-lender attempts to stem the home foreclosure crisis so far have mostly focused on loan modifications or refinancing -- giving borrowers a temporary or permanent reduction in their monthly payments.
But some housing experts say the next wave of help will have to address the core problem for many homeowners: negative equity.
This camp believes that there is no alternative but outright forgiveness of a substantial chunk of mortgage debt for many people who are underwater in their homes and at risk of foreclosure.
If your mortgage is worth significantly more than your house, your incentive to walk away may rise even if your monthly payment goes down. The decision to walk becomes a matter of simple math: If you have no hope of having an equity stake in the home for years to come -- if ever -- trading your mortgage payment for a much cheaper rent payment may be an economic no-brainer.
Right about now, many readers' outrage meters no doubt are in the red zone. Forgiveness? Let them off the hook, permanently, for some piece of a debt load they shouldn't have taken on in the first place?
The response from proponents of forgiveness is the same just-suck-it-up justification offered for every housing bailout program: The rest of us will pay, one way or another, if home prices keep falling because more foreclosed properties end up dumped on the market.
Given the alternative, the argument goes, why not try to sustain as much owner-occupied housing as possible?
One proposal for a debt-forgiveness program was floated this month by the Milken Institute in Santa Monica. The plan, authored by institute President Michael Klowden and regional-economics director Ross DeVol, would refinance existing mortgages of underwater homeowners with new loans from the government.
Klowden and DeVol call it the "homeowner principal forgiveness vesting plan." Here's how it would work:
Say an owner's mortgage is worth $400,000 but his house is valued at $300,000. The government would refinance the $400,000 loan with two new loans. Fannie Mae, the mortgage financier now under government control, would provide a first loan for the market value of the house, in this case $300,000. The Treasury would issue the second loan, in this case for $100,000.
The Treasury loan would be interest-only and would provide the vesting part of the program. For each year that the homeowner keeps up payments on both loans, one-fifth of the Treasury loan would be forgiven.
"This gives homeowners the incentive of returning to a positive net-equity position before their hair turns grey -- maybe even in time to pay for their children's college education," Klowden and DeVol wrote in a summary.
They estimate that the cost to Treasury (and thus to taxpayers) of saving 1.5 million homes from foreclosure or abandonment with this plan would be between $75 billion and $100 billion. That assumes the government wouldn't jeopardize the original lenders' balance sheets by forcing them to share in the cost via haircuts on their loans.
DeVol concedes that the Milken proposal would be a handout to the usual suspects in the housing crash -- mainly, California, Florida, Nevada and Arizona -- because those are the places where the negative-equity problem is dire.
So Nebraska doesn't need the program, but would have to help foot the bill.
The Milken plan would partly be aimed at a subset of homeowners who almost certainly would garner the least amount of sympathy from the rest of the country: People who might be able to continue making their payments, but who have no economic interest in their house because of negative equity.
How many homeowners in that situation would walk away? A new study by a team of researchers including Luigi Zingales, a University of Chicago finance professor, estimated that 26% of current mortgage defaults are "strategic" -- meaning homeowners chose to default even though they could afford their loans.
Based on surveys of U.S. households the study also found, not surprisingly, that the willingness to walk away rises as negative equity increases.
The Milken proposal doesn't delve into the details of how to determine eligibility for debt forgiveness, other than the basic qualification of being underwater.
Ken Rosen, chairman of the Fisher Center for Real Estate and Urban Economics at UC Berkeley, believes that, as a starting point for forgiveness, "It should only be for people who had equity in the first place." Many people, of course, did not.
Rosen favors a variation on debt forgiveness to give underwater homeowners a reason to stay put: a mortgage refinancing program that would turn some percentage of a homeowner's loan into an equity stake for the lender. If the house rises in value over time, the lender would share in that appreciation.
Richard Green, director of the USC Lusk Center for Real Estate, also favors the debt-for-equity swap concept to permanently reduce mortgage balances for struggling homeowners. The need is chronic, he says, in places like Riverside County, "where prices aren't coming back to where they were maybe in our lifetimes."
So far, the Obama administration hasn't embraced any ideas for U.S.-led debt-forgiveness or debt-for-equity swap programs, preferring to rely on plans it introduced this year to spur refinancings and temporary loan modifications. Officials have said they believe the programs could keep 3 million to 4 million people in their homes, of the 7 million to 9 million households estimated to be at risk of foreclosure.
But just as the U.S. in the 1930s took over and restructured more than 1 million mortgages via the Home Owners' Loan Corp., some experts believe there is no way around a bigger federal role this time, focusing on outright debt reduction for people who are in far over their heads.
"The idea that these loans are worth face value is a fiction," Green said. "If we don't deal with [reducing] the balances, we're not really dealing with the problem."