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The U.S. housing market has been in a depression for some time. I've been told not to worry, that it's just a correction of a previous bubble, but I think it's more serious than that. I'd like to propose that the main problem with the current housing market is not foreclosures, jobs, short-sales, bad loans, easy money, too much supply, or not enough buyers... no, the real root-problem is declining house values, and now too many people owe more than their house is worth. Nearly 25% of all mortgages are upside down... 25%!!! For me, this is probably the scariest thing I've ever heard, and here's why:

1. Housing is usually a person's largest investment. Want to see depression, anger, outrage? Tell the Jones's that not only have they entirely lost their biggest family investment, but that their biggest investment has just turned into their biggest liability.
2. The rise of the "walk away" solution. Do underwater homeowners want to bring $10,000 to over $100,000 in some cases to the table in order to sell their home? Most probably don't. They'd simply rather foreclose than deal with such a huge debt, and I can't say I blame them. Here's where I think the Obama administration went wrong when trying to come up with a "solution": the ability to pay is not the main reason for forclosures, it's the desire to pay. No one wants to "feed" a loosing mortgage only to see their total debt continue to rise to astronomical levels, many would simply rather get out and move on, start over.
3. Creating a vicious cycle. As more and more home-owners choose to walk away, values decline further, causing more and more homeowners to become underwater, thus repeating the cycle.
4. Market Re-programming. Because of the recent decline in home prices, people are now being re-programmed to think that maybe owning a house is not such a great idea.  As values decline further, fear sets in, taking even more buyers off the market, thus causing houses to decline even further.  It wasn't too long ago that no one ever imagined a house going down in value. It's tough to say just exactly what the long term consequences of this change in mindset might be.

On the contrary, some would say that being underwater isn't a huge problem for most people, as they'll just wait until their values return so that they can then sell without taking the loss. The problem with this arguement is that it relies on 1) values going back up and 2) people being willing to wait that long. For some, that requires a tough stomach and a lot of faith, both which are increasingly difficult to do once you've been re-programmed for declining values. I'd also argue that if 25% of homeowners are doing this, then there's no way values will return to normal with so many people potentially just waiting on the sidelines to sell.

So what's the solution? Unfortunately, I think the only solution in this case is dramatic government intervention to stop the root problem, declining home values. If we can somehow stop this problem, people will find a way to pay their mortgage... because they want to... and more and more people will be attracted to buying, thus increasing demand and getting rid of supply. The trick is to do this temporarily, and at the risk of over-using a term, provide a good "exit strategy" for this intervention. So yes, in this case I would argue for some sort of a bailout.

I've come up with a plan to help main street while helping wall street at the same time.  No one wants to give anyone (mainstreet or wallstreet) a complete get out of jail free card, but the necessary evil is that something must be done, or we must struggle through an enormous recession and downturn in the economy.  Since the decision has already been made to do something, this article focuses on what should have been done to help mainstreet instead of just bailing out wall street's bad debt.

Step 1: Government buys all "upside down" loans and loans where the LTV is greater than 80%.  The central reason for this economic downturn is the decline in housing prices.  Average homeowners see their largest asset suddenly turn into their largest debt as they owe more on thier house than it is worth.  If the government is going to spend a massive amount of money, I would argue that money would better be spent on something that would primarily help the average tax payer while providing an outlet for banks to get rid of potentially toxic loans at the same time.  The most risky loans out there are loans for more than the house is worth, or loans where the loan to value is greater than the historical standard of 80%.  If the government is given the option to buy these loans from the banks (at a discount that the banks would pay for), the banks would suddenly have a way to get all of these loans off of their books -- help for wall street, but at a penalizing discount too.

Step 2: Government resets these loans to 0.00% interest.  Yes, that's right zero percent, zilch.  Suddenly homeowners are paying 100% principle in their monthly payments, and their monthly payment go down by hundreds of dollars a month.  People who were tempted to take the foreclosure route before, would now be crazy not to take advantage of 100% principle payments -- the opportunity of a lifetime, so these people will more than likely stay in their homes.  There would be no reduction in principle owed so main street doesn't get a complete bail out either.

Step 3: When LTV reaches 80%, loans are reset to original amoritization schedule.  When the loan to value is back down to a reasonable level, like 80%, the interest rate kicks back in.  Yes, the payments go back up, BUT there is an incentive to make the payments now that you have 20% of your home's value.  If you can't make the payments, you should be able to sell your home and at least break even.  This works because presumably these loans will reset at different times, thus avoiding a sudden influx of home inventory on the market.

Step 4: Change the rules.  Writing bad loans, wall street creating credit insurance worth many more times than the actual loan values, and preditory lenders all need to be curtailed.  Capitalism is great, but only with laws and rules to ensure that no one cheats the market or each other.

Is this fair?  No, not totally.  Those who have not indulged or who have wisely paid down the balance on their home won't get any direct help.  However, everyone will see their home values stablize and begin to trend upward again with the deflux of inventory from the market.  This won't be a permanent solution, unless things are done to ensure that homes are not being bought that shouldn't be and people are not getting the kind of loans they shouldn't be, otherwise we will be revisiting this situation again in the near future.