Should principal balances on mortgages be reduced for homeowners who can’t (or won’t) make their payments?

That’s a big question facing the 5 largest servicers (read BofA, Wells Fargo, Chase, Citi and Ally Financial) on Wednesday. As part of the effort to clean up the robo-signing mess in states that have judicial foreclosures, the attorneys general of the 50 states plus the fed issued a 27 page “Settlement Terms” document that is intended to provide more safeguards of procedural rights for the foreclosure process.

But a part of this document (see paragraph VI – Monetary Relief) has a single paragraph that states “a substantial portion of monetary relief shall be dedicated by Servicer to support an enhanced program of sustainable loan modifications including principal reductions.”

This concept is causing a raging philosophical debate. Is it fair or right for a homeowner to have his debt reduced while his underwater neighbor is still making payments on his negative equity? Let’s see what Wednesday brings…