Mortgage principal – to cut or not to cut – has grabbed a fair share of the media spotlight in recent weeks. A number of experts and analysts are plugging principal

reduction as a practicable means of ensuring payments keep coming in and homeowners don’t redefault on their modified loan.

A new study by Santa Clara University’s Leavey School of Business puts the numbers and calculations to the test, and the report’s author, Sanjiv R. Das, concluded that “lenders should forgive, not forsake, mortgages.”

Das’ paper states that trimming the principal is “not a favored recipe” among lenders and is often prohibited by agreements with investors. But one such group of prominent mortgage loan stakeholders isn’t standing in the way of principal forgiveness – in fact, they are lobbying Congress to enact legislation to address the problem of underwater mortgages by reducing the homeowner’s debt.

The Mortgage Investors Coalition represents holders of some $100 billion in mortgage securities and includes such name as Fortress Investment Group, ICP Capital, and HBK Capital Management. According to a report from Reuters, the organization pitched a proposal to House Financial Services Committee Chairman Barney Frank last week that focuses on principal writedowns for second liens.

During the housing boom, when it seemed property values could only go up, homeowners enhanced their wealth (but increased their debt) by taking out secondary home equity lines of credit. These second liens are now impeding some modifications, and according to research from Amherst Securities cited by Reuters, they are attached to more than half the mortgages in private mortgage-backed securities (MBS).

Micah Green, an attorney representing the Mortgage Investors Coalition, told the news agency that the investors are prepared to consider a principal reduction plan where losses are shared, rather than completely wiped out in exchange for an incentive payment, as the Treasury has outlined in its second lien program under the Making Home Affordable plan.

As Reuters explained, under the coalition plan, investors would forgive principal to 96.5 percent of homes’ value, clearing a path for borrowers to refinance into a federally backed mortgage.

Green, of the Washington law firm Patton Boggs LLP, told “Reuters that he believed this softened position on second liens could help break the impasse keeping large servicers from forgiving principal. He called the proposal “a natural evolution” for the government’s Home Affordable Modification Program (HAMP). Investors want it because they, like homeowners, are in bad loans, Green explained to the news service.

Recent analysis from the credit ratings agency DBRS shows that mortgage restructurings employing principal writedowns increased to 13 percent of all modifications in the third quarter of last year, up from 10 percent in the second quarter and 3 percent in the first.

But while speculation has grown that the administration may be preparing to make principal reduction a centerpiece of HAMP, officials have repeatedly stated that no such alterations to the program are in play.

“There is a growing sense of concern among policymakers that the lack of homeowner equity is really getting in the way of providing a solution to homeowners,” Green told Reuters.

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