Bondi should embrace lower mortgage principals

Florida Attorney General Pam Bondi is against asking banks to reduce the amount of principal owed on underwater houses.

Is she also going to oppose sandbags and plywood during hurricane season?

We live in a state in which nearly half of all mortgage holders owe more than their homes are worth. We're not just under water. We've sunk to the sandy bottom and we're waiting for a rescue diver.

Bondi, as the top legal officer in the state, is in a perfect position to jump in. But she's not.

Instead she's arguing that reducing a home's principal is outside the scope of settlement talks with the five largest banks under investigation by state attorneys general for everything from abuse of the legal system to failing to respond to distressed homeowners.

Reducing principal, like any loan modification, is a serious step to take. It's controversial because it alters the core of the loan agreement, not just the interest rate or length of the loan.

There's something about changing the principal that grates against many of our ground rules for capitalism.

But it's hard to argue that the market should just run its natural course when taxpayers already spent billions of dollars to bail out the banks.

Why, then, shouldn't principal reduction be yet another option in Florida and other states' efforts to keep people in their homes and cut down on the number of foreclosures?

Bondi is part of a small group of attorneys general who say it creates an "unintended moral hazard that rewards those who simply choose not to pay their mortgage."

New flash: the entire system is already a moral hazard. Troubled homeowners figured out long ago that the only way to get any attention from their lender was to stop paying. And guess who they heard that from? The banks themselves.

In fact, the 27-page term sheet that the attorneys general led by Tom Miller of Iowa used as a starting point for negotiating real reform with the banks includes this proposed change: "Servicer's employees shall not instruct, advise or recommend that borrowers go into default in order to qualify for loss mitigation relief."

Bondi should know that people are already choosing to withhold mortgage payments in order to gain approvals for loan modifications or short sales. Adding principal write-downs to the mix isn't going to make much of a difference.

Except, of course, when it comes to the success rates of those loan modifications. Recent studies have shown that homeowners who receive a principal reduction as part of their loan modification are far less likely to default again than homeowners who only receive far more common interest rate reductions or extensions on the terms of their loans.

And there's also the psychological impact. One reason people default is because they feel so defeated. For those who bought at the market's peak, home values have fallen 50 percent or even more from their purchase price.

No one is advocating for across-the-board reductions in principal for every homeowner whose equity has turned negative.

While there may not be a perfect system, there is a way to target principal reductions to certain homeowners who meet certain standards.

Even Bank of America, one of the lenders targeted in the states' investigation, thinks so.

It started a program for underwater homeowners last year. And it's moving forward with principal reduction programs in Arizona, California and Nevada.

Those three states are using some of their federal Hardest-Hit fund dollars to push principal reductions for homeowners who meet certain qualifications.

For Bondi to keep the state from pursuing that option as part of a potential settlement would be wrong. Like the hours before a hurricane, we need to throw every sandbag and piece of plywood protection we can find at the foreclosure storm.

bkassab@tribune.com or 407-420-5448. Read her blog at OrlandoSentinel.com/thebottomline.

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