With principal reductions, price discovery occurs with greater latency than via foreclosures. But it occurs, nonetheless. Suppose a borrower bought a house for 500K at the peak, gets a writedown to today’s market value at say, 250K. When they go to sell the house at some point in the future, they can sell the house for 275K, pocket a small profit, and still contribute to the decimation of the neighborhood comps. Now contrast that a clearly inflationary bailout tactic: the Government’s targetted monetization of agency debt with the goal of reducing mortgage rates to an artificially low level (say 4%). This is clearly inflationary. So is reducing a borrower’s interest rate, in a loan workout, to 2% (or whatever).
Look, I’m not saying principal reductions are a good thing. If I ruled the land, I would let foreclosures run their natural course and let house prices fall unimpeded until they reached the level where Mr. Market says they should rationally be. I’m just saying that the flavor of the bailout matters. Principal reductions do not, generally speaking, reinflate house prices. They are hideously unfair, I’ll grant you that.
As to your questions about how I’d feel if half my neighbors got writedowns… I’d be pretty pissed (I thought that was pretty clear from my original post). However, like many on this board, I’m currently a member of the greatest underclass in the land: I’m a renter. From a practical standpoint, I just see principal reduction lottery winners as just another category of home sellers (along with bank REOs, shortsellers, and equity rich downsizers) who can now afford to sell me a house at 2001 prices.
