Housing regulators have not taken the idea of principal reduction off the table, but how it would be put into action is still up for debate.

An article in Bloomberg said that Federal Housing Finance Agency Director Mel Watt is still studying the idea of reducing principal on properties with depressed values, a step backed by housing advocates and Democratic lawmakers.

If the agency does decide to allow debt cuts for some borrowers, “I think it will be substantially narrower than the vision people have,” Watt said. “Reducing everybody’s principal would cost taxpayers billions.”

About 5.1 million homeowners, one in ten of those with a mortgage, had negative equity in the third quarter of last year, according to data from CoreLogic Inc., a number that has been declining as home prices have recovered. Congress could pass a tax break if lawmakers want to aid underwater borrowers, Watt said.

In follow-up to the news, Brent Nyitray, director of Capital Markets with iServe Residential Lending, said, “Any plan will be 'narrow' and will have to be done without incurring costs to the taxpayer. Interestingly, by cutting mortgage insurance premium and G-fees, he is effectively increasing costs to taxpayers by increasing the chance they have to bail out the fund. Given that we are within 5% of peak levels, according to the FHFA Home Price Index, Watt can probably make this problem disappear by running out the clock. Note that Watt says mass principal forgiveness would cost the government billions.”

A previous Black Knight report found that if any solutions go through, delinquent underwater borrowers would require up to $89 billion in write-downs.

There are currently approximately four million borrowers in negative equity positions, representing nearly $800 billion in outstanding balances, with $157 billion of that being underwater.

For the 365,000 delinquent underwater loans backed by Fannie Mae and Freddie Mac alone, it would require nearly $18 billion in write-downs.

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