Mortgage Principal Writedown Won't Save Housing

And so it begins. Big gun lawmakers are making the move toward principal writedowns as the last resort to save the housing market.

In a letter to the CEOs of Bank of America, Wells Fargo, JP Morgan Chase and Citigroup, House Financial Services Committee Chairman Barney Frank wrote, "To save homes on a large scale, we must move past temporary modifications in interest rates or terms and focus on permanent principal reductions that result in truly sustainable mortgages."

I agree and disagree with that statement: I agree that temporary modifications (even though the Treasury calls them permanent) are going to keep some borrowers in their homes for a while, but are really just prolonging the agony. I disagree that principal reductions will create truly sustainable mortgages.

The problem is prices. Home prices have fallen so far in the hardest hit areas, the areas where the bulk of the troubled loans are, that banks would have to write down principal 30 to 50 percent to put borrowers back in the green. Accounting rules require that banks write down the value of those loans on their books, and experts tell me that if banks really accounted for all the losses in the home loan market, they'd all be insolvent.

That's why the Obama Administration has created this kind of shell game in the first place.

I stole that shell game idea from housing consultant Howard Glaser: "We're spending tens of billions of dollars on a tax credit to get people to purchase homes, we're spending federal money to keep them in their homes through the modification program, and now we're going to pay them to move out of their homes. This is not a sustainable system for the housing market. It's a shell game. Bernie Madoff could have created this system," Glaser told me today.

Chairman Frank is focusing on second liens, blaiming them for holding up the first lien modification process. But the largest second lien holders are also the largest first lien holders. "Large numbers of second liens have no real economic value," writes Frank. He's right.

These lenders are getting pennies on the dollar even when they do get some kind of payoff, and they get nothing in a foreclosure. His theory is that if you get rid of the second lien then the first lien can be written down just fine and dandy. But the banks don't want to write down the first liens either. Why? Simple math.