Several major banks are putting foreclosures on hold while they try to work out loan modifications. I’m not optimistic that it will have much of an impact except to delay some foreclosures, although delaying some foreclosures might be a good way to take some of the downward momentum out of prices as we approach a bottom in many parts of metro Phoenix.

The article from Jack Guttentag mentions why real estate loan modifcations haven’t worked.

An excellent study by Alan M. White provides some indications of what has happened to modifications during this tumultuous period. In a sample of subprime loans he examined, the mortgage payment was reduced in only about half the modifications, and the balance was reduced in very few cases. In many cases, the modification consisted of adding the amounts past due (“arrearages”) to the balance, which raises the payment. It is no wonder that during the annual period he examined, the number of foreclosures swamped the number of modifications.

My opinion is that loan modifications won’t work because home prices have fallen too much. Loan “mods” would only work if a significant amount of the principal is forgiven by the bank.

There is, however, a huge problem with forgiving principal.

If banks forgive some principal for those who haven’t paid their mortgage, then a lot of other people will simply stop paying their mortgages and want a principal reduction too.

That idea could very well spread like smallpox and if it did, it would be the end of the financial world as we know it.

Fortunately, much of Arizona residential real estate is set to bottom out next year. Unfortunately, new government programs could mess that up big time.