Are Principal Reductions Coming?

As I just mentioned, I attended a blogger session today at the Treasury, with lots of senior officials, including Secretary Geithner. A variety of topics were discussed, and many interesting things said. One topic that they spent a short time on was the housing market. I didn't get the question in I wanted to ask (so I'll try to contact the Treasury in the days to come for clarification), but someone asked if the Treasury is going to be following the FDIC's lead when it comes to considering principal reductions for mortgage modifications.

Much to my surprise, the answer was a pretty unambiguous yes. The official speaking said that in the days to come we will likely see the Treasury moving more towards principal reduction as a tactic to modify mortgages. I found this a little surprisingly, mostly because the current Treasury modification program has little to say about principal reduction. While it certainly allows for it, the program relies more on carrots for servicers and banks to make modifications happen. Those modifications usually just involve term extensions and interest rate reductions.

I'm curious as to what changed the Treasury's course here. Perhaps it was the dismal results of its modification program thus far. The Obama administration may have come to the realization that you can't modify many mortgages in this environment unless you find a way to encourage banks to stomach principal reductions. It remains unclear how the Treasury intends to reduce principal, however.

The question I didn't get to ask was how Treasury's philosophy towards the housing market has changed over the past year, and what its strategy is at this time. This morning, I noted that the Treasury is starting another program meant to encourage more short sales. That appears to conflict directly with the idea that struggling homeowners should remain in their homes. Indeed, if principal reductions begin, then the pendulum swings back in the other direction away from encouraging short sales. There appears to be a sort of scattershot approach at this point, and I am curious whether there's some unifying strategy that I'm just missing. I'll try to find out this week.

Update: One of the other bloggers there, Shahien Nasiripour, got an e-mail from a Treasury Spokesman after-the-fact indicating that any new principal reduction approach would be more of a tweak in existing modification programs than a major, new program.