The Center for American Progress proposed a pilot shared-appreciation program to ease the burden of possible principal reduction on Fannie Mae and Freddie Mac mortgages.
The Washington think tank said such a program could be concentrated on mortgages at a loan-to-value ratio above 115%, facing a hardship and ideally with no second lien attached.
But unlike Ocwen, which would actually restore 5% of equity for a borrower, the CAP analysts said it would only be necessary to write down the principal to between 110% and 120%. It is the same range the Treasury Department said it would target.
Under the proposal, Fannie and Freddie would receive half of any future appreciated value in the home in exchange for offering to reduce the principal. But the analysts left room for the GSEs to take more of the appreciated value depending on the condition or location of the property. If the home is in an area where a recovery is expected to be slower, for example, the GSE could take more of the appreciated value.
Roughly three-in-four underwater GSE borrowers are current on their loans, according to CAP. For the other 25%, the shared-appreciation program could be done on a loan-by-loan basis when it benefits the investor over foreclosure.
Doing the reductions under the Home Affordable Modification Program would mean borrowers would have to be delinquent, though, raising the moral hazard question.
"The last thing Fannie and Freddie want to do is to push those current borrowers into unnecessary default," CAP analysts admit.
But they also proposed either limiting the program to only those borrowers who are either delinquent now or can show they are on the verge of falling behind.
"Considering these complexities, it's clear that eligibility must be determined on a loan-by-loan basis," CAP analysts said.
The Federal Housing Finance Agency, which is conducting a new analysis of the cost for doing principal reduction under HAMP, said previously such an arduous process would add costs for technology, guidance and training of servicers. Fannie and Freddie would eat more costs to change accounting and tracking systems.
"Unless there is an expectation that principal forgiveness will reduce losses, we cannot justify the expense of investing in major systems upgrades," the FHFA said.
The proposal from CAP gives a few options for Fannie and Freddie to work around the second lien and mortgage insurance issue. Both of these stakeholders should be put in a "first-loss" position, the analysts said.
According to William Emmons, an economist with the Federal Reserve Bank of St. Louis, the market would have to restore $4 trillion in lost equity in order to return housing to a more normalized level.
Anthony Sanders, a professor of finance at George Mason University, said that it would be a bad idea for government to try to fill that gap.
"As the economy improves (I hope) and house prices stabilize, we will eventually grow our way out of the negative equity problem," Sanders wrote Thursday.
James Frischling, president and co-founder of NewOak Capital, said a shared-appreciation proposal would be the best option available for the GSEs. Foreclosure, because of the delays and costs, is simply too expensive.
"The second lien should already be considered wiped out, ultimately, that's where we have to get to. In these situations, too many constituents talk their book. The second lien holder can't have standing in order to right this ship," Frischling said. " I think this is the best situation, where you're choosing the lesser of all the evils."