Let's Lower the Principal on Bad Loans

I find myself agreeing with recent editorials in the New York Times that advocate lowering the principal on bad loans, instead of President Obama's plan to lower interest payments.  What impressed me about this editorial is that they study the rates at which people default (walk away) from their mortgages.

"... default rates for subprime mortgages and other non-prime mortgages are stunningly sensitive to whether a homeowner has an ownership stake in his home. Every month, another 8 percent of the subprime homeowners whose mortgages (first plus any others) are 160 percent of the estimated value of their houses become seriously delinquent. On the other hand, subprime homeowners whose loans are worth 60 percent of the current value of their house become delinquent at a rate of only 1 percent per month."

Since our goal is to prop up housing prices and reduce "toxic" assets by reducing foreclosures, this is strong evidence that reducing principal is a far superior approach to reducing payments.  I think of it as "sabremetrics" applied to politics / economics.

Still, I'd add some wrinkles.  Taxpayers taking a hit to lower loan principal is a nice carrot for those who made bad loan decisions.  There should be some stick.  Ideally, I'd propose that the names of those receiving this benefit be added to a "you blew it" list.  When the next bubble bursts, the same people who received this gift on their mortgages shouldn't go clamoring to the government cause they were stupid or took big risks and lost yet again.  We don't want to reward bad behavior without consequences since it will simply encourage future bad behavior.  In effect, give these guys a yellow card and say "this is, literally, a once in a lifetime bailout".

Such a list is probably hard to maintain.  So, as an alternative, penalize the recipients of this taxpayer largess by reducing the tax deductibility of their interest payments.  Or give the taxpayers a small equity stake in the house.  If they sell it later at a profit, Uncle Sam gets 10%.  And there probably needs to be a blackout period - they can't immediately sell / flip the house and make money just after taxpayers lowered their principal!  No sales for, say 5 years.

This bailout will be more palatable to the great majority of Americans who didn't screw up, if they also get a benefit.  Moderately wealthy non-house owners have arguably benefitted from low interest rates and the huge decline in housing prices.  Many first time buyers can now afford houses.  So, to some extent, they are covered.  Poor non-house owners are getting some nice tax breaks, and will (hopefully) benefit greatly from Obama's initiatives in health care and education. 

I propose that current home owners (with a mortgage), who have not gone underwater with poor or greedy decisions, also receive some benefit.  Either a direct payment, or, more likely, increased tax deductibility of their interest payments.  In the interest of full disclosure, I'd benefit from this.

These tweaks takes a good idea and make it more fair to all.  Thoughts???