Many people here (and many of our Representatives) have suggested that mortgages cramdowns (the policy of adjusting the terms/principal of a mortgage in or in fear of default) would be a good idea to both stop the current financial crisis and to give something back to the "people" as part of any bailout package. I am going to tell you why this won't work and would be political suicide.
First, let's remember that only 6% of mortgages are currently in default, while nearly 30% are underwater (you owe more than your house is worth) by most estimates. This data exposes a major problem with any cramdown policy, as it still misses a huge number of "worthless" mortgages that are at the heart of the current crisis (the fear of future defaults is a major reason that these mortgage backed securities are not trading). As a corollary to this is the potential problem that a cramdown policy could create more defaults, as it would give people an option to default in order to take advantage of the program, which again would have serious negative impacts on the credit crisis, as it would cause further losses in those mortgage backed securities. This policy is simply one, that while looking reasonable on its face, would have really bad unintended consequences when enacted, as the idea of cramdowns was never meant to be applied to systematic failure of a market.
The other problem with this policy is that it would be political suicide. Remember, the vast majority of people in this country (94%) are current on their payments even though many of these people are also underwater on their mortgages. Think of the outcry and discontent that would be created when the guy across the street gets his $300,000 Las Vegas mortgage reduced to the current market price of say $215,000, while you are still living paycheck to paycheck paying your $300,000 mortgage for the same house that is now only worth $215,000. Politically, this is a loser of a policy simply because of the systematic nature of the current problem. In the past when cramdowns were allowed, we were not facing national price declines that caused 30% of homeowners to be underwater. With that now the reality, there is no way that principal cramdowns can be a viable option.
***I want to be clear that I am not against the cramdown of mortgage interest rates to current market levels.