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Zywicki in Washington Times: No Windfall for Delinquent Borrowers at Expense of Responsible Consumers

"Lenders and loan servicers should pay the price for whatever wrongs they have committed. But their punishment should not result in a windfall to delinquent borrowers at the expense of responsible consumers and setting back a housing market recovery," says Professor Todd Zywicki in a Washington Times op-ed.

Forced principal reduction is the wrong solution to lender misdeeds, says Zywicki, pointing out that while the behavior of mortgage servicers has been in some cases indefensible, homeowners who face foreclosure have in many cases made an economic calculation to walk away from their investments. 

Forcibly reducing principal would probably provide a temporary reduction in the foreclosure rate, says Zywicki, but it would make the problem worse in the long run.

"If government officials force principal reductions because of shoddy paperwork or previous misdeeds, then they are inviting a moral hazard problem on a nuclear scale," he warns, stating that another serious recession could result through policies that have the potential to collapse the nation's housing market.

Lender punishment mustn't reward defaulters; Forced principal reduction is the wrong solution to foreclosure fiasco, Washington Times, June 10, 2011. By Todd Zywicki.

"Nor would writing down mortgages provide a real solution to the housing crisis - in fact, it would make it worse. Forced principal reduction might alleviate foreclosures crisis in the short run by reducing the incentives borrowers face to walk away from an underwater home. In that sense, we've learned that houses fundamentally are no different than any other financial asset. Each month, the borrower has a financial option. He can treat it as a call option and make his payment on the mortgage for that month and retain the option of making 30 years worth of payments, at which point he will have purchased the asset. Or he can instead treat it as a put option and instead of making the payment, he can instead default on the mortgage and put it back with the bank through a foreclosure process. Unsurprisingly, economists find that where the value of exercising the put option rises (such as when the house falls in value) or the cost of exercising the option falls (such in states that have so-called 'anti-deficiency' or 'nonrecourse' laws that limit the lender's remedies in the event of default), foreclosures tend to rise."

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