1. One of the excuses which The Powers That Be use to prop up house prices is "the specter of negative equity", which they know did for the Tories after 1992.
2. Now, as we remember from our lessons in finance, there is a fixed mathematical relationship between four variables: the principal amount of a loan, the term, the interest rate and the annual capital and interest payments required to pay it off. And these calculations are exactly the same for annuities (i.e. what you are supposed to spend your pension pot on). So if you know three of these variables, you can can calculate the missing one.
3. It is not very pleasant having a mortgage which is bigger than the value of your home but this is purely psychological.
4. The annual repayments have to be paid out of your annual income, not out of the value of the house - a mortgage doesn't automatically cost you more just because you are in nequity (glossing over the fact that the banks will bump up the interest rate). And banks don't like negative equity either, as only part of the loan counts as "secured", even though ultimately, loans are only secured on their borrowers' future earnings.
5. So what "the government" could do is allow house prices to fall by (say) a quarter and take any nequity-tainted mortgages off the banks' books. Borrowers are given a smaller replacement mortgage equal to the value of the house, and banks are given new government bonds with a nominal value equal to the existing principal (they do not have to recognize losses because there aren't any).
6. This need not be a get-out-of-jail-free card for borrowers... because the government can set the interest rate on the new loans slightly higher, so that the annual repayments (receipts, from the government's point of view) over the rest of the mortgage term are the same as they would have been at the old lower rate.
7. And the government could make a small mark-up on the deal as well. The interest rate which it has to pay (or which banks will demand) on government bonds is (say) 1% lower than the interest rate which normal borrowers were paying (because of better credit risk), and it can pool all these mark-ups to cover it against any actual losses incurred.
8. Here's the spreadsheet for you to muck about with. You can change the figures in the yellow boxes, the rest is functions (PMT and RATE).
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