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House Democrats Call for Principal Reduction, but Tax Time Bomb Would Make That Damaging for Borrowers

Here’s a case of just not understanding what’s going on. Yesterday, Elijah Cummings and 18 House Democrats wrote a letter to the President and lead Congressional negotiators on the fiscal slope, urging them to include “provisions that will provide assistance to homeowners who are currently underwater on their mortgages” in the final deal.

This sounds perfectly reasonable at first glance. The economy could use the boost from continued deleveraging, and debt relief would deliver that in an excellent manner. But specifically, the House Democrats want the deal to include a measure that would force Fannie Mae and Freddie Mac to reduce principal on underwater mortgages in their portfolio if the net present value test shows this to be positive (in other words, if the test shows that it would ultimately save Fannie and Freddie more money to reduce principal relative to other options with a higher risk of foreclosure).

Again, nice sentiment. I believe principal reduction should be mandated if it’s NPV-positive across all loans, not just Fannie and Freddie. That is, it would be nice, if the Mortgage Forgiveness Debt Relief Act weren’t about to expire in 19 days. If a fiscal slope deal included this mandated GSE principal reduction, and the MFDRA doesn’t get extended, then all principal forgiven will count as earned income for those underwater homeowners. This will kick them into higher tax brackets, and introduce a tax burden upon them that they are overwhelmingly likely not to be able to afford. The House Democrats might as well have said to the lead negotiators that they should include in the final deal a measure to put underwater homeowners into debtor’s prison. That’s the effective outcome of their proposal.

Some of the people who signed this, like Brad Miller and George Miller and Barney Frank, know better. There’s nothing wrong with pushing on all levers to try to get relief for homeowners. But this is a serious case of putting the cart before the horse. If you want to pressure negotiators on something, why not pressure them on extending the Mortgage Forgiveness Debt Relief Act? The answer is that it costs money; but considering it’s a major impediment to debt relief that would improve the economy and boost tax receipts, it will pay off big in the future.

Until the Mortgage Forgiveness Debt Relief Act gets extended, talk of principal reductions is just irresponsible. That’s why it’s so critical to get that debt relief tax exemption done.

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David Dayen

David Dayen

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