Consequently, it would act as a stimulus. Let's say your mortgage was based on original principal of $250,000. At 6% fixed interest, that would make your payment around $1500. But let's say the housing bubble dropped your property value by 30%, so the home is only worth $175,000. Now, let's say that you had paid off $25,000. That leaves $50,000 in principal that the GSEs could potentially write down. Suddenly, your payment would drop to as low as $1,050. What would you do with that extra $450 per month? The Obama administration would hope that you spend it!
This would effectively transfer wealth from all taxpayers to middle class homeowners, since it would only benefit those who have mortgages with the GSEs. The upper class generally has either very large ("jumbo) mortgages that don't qualify for Fannie and Freddie's backing or they own their home outright. Poorer Americans, however, don't have mortgages at all -- they rent. So they wouldn't benefit either.
Whether or not this proposal would successfully stimulate the economy depends on the psychology of those lucky homeowners. We have seen recently that saving has been quite high. So it's certainly conceivable that much or most of that mortgage payment reduction would be saved or used to pay down other debt. If the recipients spent it, however, then it would stimulate the economy.
Moreover, the logistics are even harder to conceive. How will the government decide how much to reduce each mortgage by? Will there be a standardized lump sum across-the-board? Should it be based on original or current mortgage balance? Will the Treasury differentiate between housing markets that have fallen more than others? Will appraisers need to be involved to ensure that renovations weren't completed that raised the value of the home since the mortgage was signed? It won't be possible to make everybody happy here.
Make no mistake: this is a very controversial idea. Not only would it mostly benefit a specific subset of Americans, but it would also be done in such a way to tiptoe around the usual political process. Of course, considering that it is virtually impossible to pass any more stimulus at this point, this might be the administration's last chance to try to revive the economy before midterm elections. It would be hard to interpret something this drastic as anything other than an act of desperation, however, given all drawbacks of the plan and anger it would create.
Update: Treasury denies that this is being considered, with a spokesperson saying: "The administration is not considering a change in policy in this area." So we'll see what actually happens in the big August conference.