Last month I discussed the idea of government-sponsored mortgage principal reductions, which I described as the “nuclear option” in the government’s housing bailout arsenal.  As unjust and misguided a policy as this might be, I suspected at the time, principal reductions might well be on the way.

Well, the first volley of bailout nukes has been launched.  The Treasury has announced a plan to reduce loan balances for underwater borrowers by bribing lenders to reduce principal balances and refinancing borrowers into FHA loans with lower amounts.

So it has begun.  The only question is how far it will go.  This particular program is supposed to be funded by $14 billion out of existing foreclosure-prevention funds.  But as we have seen, when it comes to the bailout, the rules are changed when it becomes convenient. 

This is really the first foreclosure-prevention approach to date that is likely to actually prevent foreclosures.  Now that the principal reduction line has been crossed, we could see a lot more of it — and it could have a huge impact on the future of the housing market.


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