Brookings Scholar: Principal Reductions The Wrong Approach

Targeting principal reduction to the 20 percent of underwater borrowers with delinquent Fannie and Freddie loans (approximately 600,000 in total) does have the potential to prevent some foreclosures, but at far too much a price. It is extremely difficult to target federal help to a select group of borrowers without providing an incentive for other borrowers to stop paying their mortgages. Indeed, research by Christopher Mayer, Edward Morrison, Tomasz Piskorski and Arpit Gupta of Columbia University found a statistically significant increase in such strategic increase in strategic behavior in response to principal reduction announcements. …

As the housing adjustment continues, we should avoid taking actions that accomplish little while providing incentives for borrowers to renege on obligations. Such efforts will only prolong the problem. (Added a link the study)