Federal Deposit Insurance Corp. Chairman Sheila Bair said Thursday that the agency is designing a principal-reduction program as part of its loss-sharing agreements. In a speech to the Sustainable Homeownership for All conference, Bair said that including a principal-forgiveness option in loans covered under such agreements is a way to reduce defaults and enhance the performance of modified loans.

The FDIC has long argued for principal reductions. Though Bair acknowledged they can be expensive and create moral hazard, she said they are the best way to maximize the loans' value and reduce default potential. "Our analysis is ongoing," she said, " … but I'm committed to doing everything possible to minimize foreclosures and stabilize housing."

The Treasury Department's Home Affordable Modification Program, or Hamp, has relied more on reducing monthly payments than on principal reduction. A Treasury report Wednesday said that 27% of Hamp workouts included a principal reduction.

Bair said she realizes Hamp is a tough task but that the industry needs to do more. "I don't think the industry has responded as it should," she said.

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