Spending power, often resulting from wider-spread employment, and the ability to purchase homes go hand-in-hand. Once demand for new homes increases, prices go up and new construction, with corresponding jobs, is possible. Yet, for all the recent talk about unemployment holding back the housing market, real estate has itself to blame, somewhat.

According to a recent piece in The Week, underwater mortgages are a drain on both the housing market and the economy. Resulting from homes purchased during the housing bubble, underwater mortgages have resulted in borrowers owing $700 billion. Presently, 29 percent of homeowners, or 14.7 million people, are paying off an underwater mortgage – one that, in fact, may be two or three times the property’s current worth.

But what about refinancing or loan modification? Think about the disparity in prices between 2007 and the present. As The Week explains, the amounts owed by homeowners are still too much for refinancing or loan modification, and to keep credit in good standing, homeowners continue to pay off these outrageous debts.

The Week proposed the following solution to getting rid of underwater mortgages and, essentially, stimulating both the real estate market and economy: forgiving these debts. Sam Khater, an economist at real estate data firm CoreLogic told the press: “Until that negative equity recedes, the housing market is not going to recover. It’s a giant anchor that’s holding back the economy.”

What do you think the best solution would be? Housing prices may not reach 2007 highs for the next few decades, and until then, homeowners with underwater mortgages won’t put their properties up for sale or, worse, will file for foreclosure, which ends up lowering the average price per home. Yet, $700 billion is a large amount still owed. The Week hypothesizes that prices could continue falling until 2013, preventing recovery of the housing market.

It’s a cliché to think of success as one step forward and two steps backward, but this overly-used saying simply describes the current state of the real estate market. Although homes are for sale in all metropolitan areas, the average home price has decreased, according to a piece in The Wall Street Journal. While minor declines have been seen over the past year, the 1.3-percent decrease from October to September is cause for concern and contradicts with the recovery of retail and manufacturing industries.

Earlier this year, the housing market appeared to be in a state of recovery: the average home price had increased slightly – but not too much – while sales were up. But the WSJ isn’t the harbinger of bad news; such a drop was predicted over the summer. And, while this news applies mainly to homeowners, what about commercial real estate’s notable recovery?

The points contributing to this decline, as expressed in the WSJ piece, include:

• The job market correlates with housing. When job growth is slow (unemployment is currently 9.8 percent), housing is too risky of an investment.
• The tax credit for first-time homebuyers expired and, as of April, the amount of sales dropped, taking this figure back to early 2010 numbers.
• 20 metropolitan areas saw declines, with prices in Las Vegas and Cleveland dipping so low they’re back to 2000 levels. Las Vegas real estate, as we discussed months earlier, has a high percentage of foreclosures, which influence the average price.
• As seen in Las Vegas, foreclosures still make up a significant amount of home sales – about 30 percent – and, as foreclosures and short sales go for less than average, they bring the price down.
• Mortgage rates are rising, and current homeowners are stuck with underwater mortgages. This leads homeowners to wonder, “Why sell my property for less than when I purchased it?”

Meeting someone half way is the essence of a compromise, but it appears that since the collapse of the housing market and financial industry back in 2008, an all-or-nothing approach has been the norm. While banks were bailed out, many homeowners who had bit off more than they could chew with an adjustable rate mortgage (ARM) were left by the wayside and, worse, ended up unemployed. Although standards for applying for a loan were changed and refinancing an existing mortgage was possible, what about those who are stuck with a mortgage on a home that, because of the crash, was devalued?

A professor at MIT proposed a solution, according to the International Business Times, that, essentially, harks back to a basic compromise and commonsense. Professor William Wheaton at MIT proposed a solution to getting rid of underwater mortgages. His approach to reconstructing consists of converting debt to equity, according to the IBT article. As many homeowners are paying a higher loan than their home is worth, Wheaton’s plan specifies that their loan would be reduced to the current market value of the property. As we saw in the case of Las Vegas, this underwater mortgage may be half of the original value.

But this plan isn’t designed only the benefit the homeowner, as the IBT mentions. Rather, the lender isn’t stuck with only a portion of the original loan’s amount. Instead, lenders will get half of the equity of the original loan and, as housing prices recover over time and because of inflation, the lender gradually recovers the original amount.

Although the lender receives this amount gradually over time, Wheaton’s solution, it appears, would reduce the amount of foreclosures and defaulted mortgages. Once the homeowner has a reasonable amount to pay, he or she has a significant burden lifted off, and the lender receives the full amount of the original loan when the market recovers with the pace of inflation.