"In modifying mortgages to make them affordable to borrowers, the loan balance is seldom reduced. Fannie Mae and Freddie Mac, in particular, don’t use balance reductions at all. Why is that?"
Your facts are right. The Mortgage Metric Report issued quarterly by the Comptroller of the Currency shows that 87 percent of the mortgages modified in the second quarter had their rate reduced, 51.4 percent had their term extended, but only 2.1 percent had their balance reduced. On loans owned or guaranteed by Fannie and Freddie, there were 10 balance reductions out of a total of 121,482 modifications.
Loans are modified by the firms servicing them, which in most cases don’t own the loans. They service them under contract with investors or their designees, and the contracts always stipulate that discretionary actions by the servicer, such as modifications, must be in the financial interest of the investor.