Not very long ago, it was common to have a second mortgage just to avoid private mortgage insurance. The first mortgage would be the traditional 80% of the purchase price. The second could be a conventional, ARM, or even HELOC for 10% or even 15% of the purchase price (MSN seems to think these are still available, but I don’t know any local mortgage brokers who do them). Many people used this sensibly to pad out the finances during a big move, and paid off the second mortgage after their previous house closed. Of course this isn’t the only way people used second mortgages: many others used their homes as an “ATM” to pay for home improvements, open businesses, and whatnot.

The point is that there are a lot of second mortgages out there and that is making refinancing, modifications, short sales, and all other foreclosure avoidance measures difficult now.

There is good news, sort of. The latest adjustments to the Federal foreclosure avoidance programs include a provision to make sure the holders of the second mortgage get something, even if it isn’t very much. It does put principal reduction for both first and second mortgages on the table, too. The hope is that 3,000,000 to 4,000,000 foreclosures can be prevented over the next 3 years. That sounds like a lot until you realize that experts like Lawrence Yun expect that many foreclosures this year alone. Given Mr. Yun’s track record, I consider that an optimistic number. Some experts think that as many as 12,000,000 homes are “at risk.” Only preventing a quarter to a third of those foreclosures is merely a smaller catastrophe for families and communities as well as anybody who works in banking, real estate, or the construction trades.

While it is certainly true that we aren’t going to work through this mess without addressing second mortgages and the fact that market value of most American homes are far below what they are mortgaged for, this is only a first step. Some think it doesn’t go far enough, that bankruptcy law needs to be amended to account for this sad reality. Others wonder how far Washington can or should go, when it is clear that nobody can prevent all the coming foreclosures; they wonder what will happen to those of us who followed the rules, and exactly how long we should let this failed government initiative continue to operate.

As for myself, I think the banks are part of the problem, and have been for some years due to the unique banking combination of bureaucracy and pursuit of profit. It is important to put in place good procedures for short sales and modifications and insist that everyone abide by them. Failure to do so will insure more foreclosures, collapsing property values, no incentive to build anything, and great incentive for those of us who “played by the rules” to walk away. But the hard part will be convincing the bank to stop pretending that the loans on their books are worth face value. If you own stocks, you know what you paid doesn’t change what it is worth now. Banks are still pretending they can get full value out of homes that are worth half that — thanks in part to the predatory pricing tactics of banks on other foreclosed properties! This will of course be big trouble for banking profits.

Once again it turns out that the problems in foreclosures and in banking are related and must be tackled together.