Finally, it’s mortgage do-over time

This month, Bank of America said it would start reducing mortgage balances by $150,000 on average for up to 200,000 underwater homeowners behind on their payments. The biggest news was the dog that didn’t bark. Few pundits or Internet commenters criticized the program as unfair to people who didn’t take on more than they could afford. The apparent evolution of public opinion is healthy. It’s just too bad that it took so long.

In the early years of the housing and credit crisis, a few academics suggested that the way to fix a crisis caused by too much housing debt was to reduce some of that debt. The facts were on their side. In the decade before 2007, mortgage debt more than doubled, adjusting for inflation, to $10.5 trillion, according to the Federal Reserve. After the bubble burst, Americans couldn’t keep paying all of that debt and support the economy with retail spending and investments in businesses. They still can’t.

Yet no mainstream politician, Democrat or Republican, embraced the idea of forcing banks and investors to admit reality on their bad loans.

Why? Public opinion was rabidly against it. A commenter to a January 2009 New York Times blog summed up the zeitgeist in asserting that “people who [bought] more house than they can afford … ARE idiots.”

Plus, politicians had a seemingly sound reason to reject the idea. Allowing Americans to get a do-over on mortgage debt would encourage more people to take undue risks, figuring they would get the same bailout. Economists call this “moral hazard.”

Furthermore, if banks and investors had to take bigger losses on mortgages, they would see the business as riskier and raise interest rates for everyone else to make up for that risk.

But now, such comments and economic reasonings have been far fewer. That’s a good thing.

The moral-hazard argument against principal write-downs was always faulty. During the housing boom, the financial and real estate industries and popular culture — TV programs such as “Flip This House” — encouraged Americans to buy a home as a speculative investment.

But when you lose money on an investment, it’s perfectly rational — and not immoral — to cut your losses.

In the business world, it’s common for lenders and investors to reduce the value of debt owed when the value of the asset backing that debt has declined. It happens all the time voluntarily in commercial and rental real estate, and involuntarily through corporate bankruptcy.

Lenders don’t reduce the amount of money they’re owed because they’re nice. They do it because it’s economical. They don’t want to be stuck managing an asset that’s lost value.

And it’s still not the best time for a bank to be taking over hundreds of thousands of houses. It may be cheaper and faster for BofA and others to keep existing homeowners in place — by cutting them a deal.

As for the issue of whether mortgage-principal reductions raise costs for everyone else in the long run: It’s not that simple.

The housing and credit bubble and bust occurred in part because mortgage borrowing was too cheap. Lenders and investors seemed to think there was no risk. It would not be a bad thing if lenders and investors came to understand that lending money against a house is risky — and charged borrowers accordingly. Such an adjustment is normal in a free market. Slightly higher interest rates would discourage people from borrowing more than they can afford.

Moreover, the more pressing problem is not that mortgage interest rates may be too high someday but that they are too low right now. The government has intervened massively, reducing rates to below 4%. President Obama and Federal Reserve Chairman Ben Bernanke encourage low rates because they want people to flock back to the housing market — creating artificial demand and keeping house prices from falling further.

That would create a new generation of borrowers who will find themselves underwater in coming years when the government stops propping up prices. That’s moral hazard — using unwitting new people to bail out the old.

The best way to avoid that risk would be to allow housing prices to find their bottom now. Such an effort is helped by mortgage-principal reductions, as they reduce uncertainty over future foreclosures.

As for why the unfairness charge is on the wane, people worried about it may be slowly learning that the more acute problem is empty houses. In a lesser-of-two-evils world, maybe it’s better for your neighbor to get a break on his mortgage than to have another hulk rotting nearby.

Then, too, people worried about unfairness may look into defaulting to get a mortgage reduction but find it’s not so easy. There’s a lot of anxiety, and not all defaulted homeowners will qualify. For many people, it may not be worth it. That’s an economic choice, not an example of fairness or unfairness.

A change in the attitude toward mortgage-principal reductions is good for the economy.

We’ve always been a nation of people who take risks, and a nation that does not throw people in debtors’ prison when those risks don’t work out. People make mistakes, or are just plain foolish or unlucky. In a misguided attempt to punish such people, we imprison the entire economy in hundreds of billions of dollars’ worth of debt shackles.

Nicole Gelinas is a contributing editor to the Manhattan Institute’s City Journal. @nicolegelinas on Twitter