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Principal Forgiveness

I brought it up a while back that I thought principal forgiveness would be the next step in trying to reduce foreclosure numbers, and sure enough, Bank of America has jumped on board.  At the time, I received a lot of negative comments which primarily stated that it would never happen because the banks would not take those losses and because the contractual language of the structured securities that held these loans would not allow for it.  What many do not seem to realize is that there are very few options for the banks to stem foreclosure losses.  Many individuals have found themselves in financial situations where the most economical decision is to strategically walk away from their houses and the mortgage loans shackled around their ankles.  Banks have been paying money to individuals who reside in defaulted residences because in nearly every circumstance, forced foreclosure can be the most devastating loss of all.  Bank of America sees the writing on the wall:

“The bank (Bank of America), the largest mortgage servicer in the country, said Wednesday it will forgive up to 30 percent of some customers’ total mortgage balance. The homeowners must be at least 60 days delinquent on their loans and owe more than 120 percent of their homes’ value.”

Bottom line, this is a case of moral hazard that I have been cautioning against. Any time that individuals or corporations are saved from their poor decisions, it sets a precedent for all future decisions made by corporations and individuals.   To understand this logic you only need to consider one man’s plight: what about the hardworking american who makes $45,000 per year, supports his family and makes every payment on his mortgage while losing his pension plan, losing vast quantities of money in his retirement plan, and has watched the value of his home decline by 30% which has placed him 20% in the hole.  How is he going to feel when his neighbor receives a 30% reduction in his mortgage because he stopped making his payments?  Under these circumstances, did the hardworking american make the correct decisions for himself and the financial health of his family?  He might have taken the ethical high ground, but next time he will likely think twice.  Meanwhile, the neighbor who got bailed out will continue to make financially reckless decisions because he never was forced to feel the pain of his mistakes.

Posted in Economics, Markets, Politics.

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