Here is Luigi Zin­gales, an eco­nom­ist with a plan:

Sup­pose that you bought a house in Cali­for­nia in 2006. You paid $400,000 with only 5% down. Unfor­tu­nately, dur­ing the last two years the value of your house dropped by 30%; thus, you now find your­self with a mort­gage worth $380,000 and a house worth $280,000. Even if you can afford your monthly pay­ment (and you prob­ably can­not), why should you struggle to pay the mort­gage when walk­ing away will save you $100,000, more than most people can save in a life­time?

How­ever, when the homeowner walks away, the mort­gage holder does not recover $280,000. The fore­clos­ure pro­cess takes some time dur­ing which the house is not prop­erly main­tained and fur­ther deteri­or­ates in value.

The recov­ery rate in stand­ard mort­gage fore­clos­ures (which will not take place in the middle of the worst crisis since the Great Depres­sion) is 50 cents per dol­lar of the mort­gage. I am gen­er­ous in estim­at­ing that under the cur­rent con­di­tions it might recover 50 cents per dol­lar of the appraised value of the house; right now, it is only 37 cents per dol­lar of the mort­gage, which given a house appraised at $280,000 equals only $140,000 for the mort­gage holder.

In other words, fore­clos­ing is costly for both the bor­rower and the lender. The mort­gage holder gains only half of what is lost by the homeown­ers, due to what we eco­nom­ists call under­in­vest­ment: the fail­ure to main­tain the house.

In the old days, when the mort­gage was gran­ted by your local bank, there was a simple solu­tion to this tre­mend­ous inef­fi­ciency. The bank for­gave part of your mortgage;let’s say 30%. This cre­ates a small pos­it­ive equity value—an incentive—for you to stay. Since you stay and main­tain the house, the bank gets its $266,000 dol­lars of the new debt back, which trumps the $140,000 that it was get­ting through foreclosure.

Unfor­tu­nately, this win-win solu­tion is not pos­sible today. Your mort­gage has been sold and repack­aged in an asset-backed secur­ity pool and sold in tranches with dif­fer­ent pri­or­it­ies. There is dis­agree­ment on who has the right to rene­go­ti­ate and rene­go­ti­ation might require the agree­ment of at least 60% of the debt hold­ers, who are spread through­out the globe. This is not going to happen.

Fur­ther­more, unlike your local bank, dis­tant debt hold­ers can­not tell whether you are a good bor­rower who has been unlucky or some­body just try­ing to take advant­age of the lender. In doubt, they do not want to cut the debt for fear that even the homeown­ers who can eas­ily afford their mort­gage will ask for debt forgiveness.

Here is where gov­ern­ment inter­ven­tion can help. Instead of pour­ing money to either side, the gov­ern­ment should provide a stand­ard­ized way to re-negotiate; one that is both fast and fair. Here is my proposal.

Con­gress should pass a law that makes a re-contracting option avail­able to all homeown­ers liv­ing in a zip code where house prices dropped by more than 20% since the time they bought their prop­erty. Why? Because there is no reason to give a break to inhab­it­ants of Char­lotte, North Car­o­lina, where house prices have risen 4% in the last two years.