Now, for the solution(s).

There's no magic bullet, no one solution that can, in one fell swoop, wipe the slate clean. As I've described it, “sopping up negative equity” is an immensely complicated task. The mortgage industry is massive, inefficient, disjointed, riddled with redundancy, buried in paperwork and plagued by bad regulation and misplaced incentives. In short, it’s a mess. Cleaning it up will take a very, very long time. 

Still, I'd argue spending money on the programs below -- without any hope of it being returned -- is a better use of taxpayer funds than watching hundreds of billions of dollars simply disappear into the opaque balance sheets of what remains of the financial system.

There may be additional solutions, but this laser focus on earning taxpayers a return on their investment dilutes the effectiveness of many important initiatives.

Principal Forgiveness

Fannie Mae (FNM) and Freddie Mac (FRE) are already experimenting with a pilot program to give borrowers the amount of their negative equity as an unsecured loan. Based on the most recent appraisal (appraisals are, for all their faults, currently the most accurate way to value individual homes), Fannie and Freddie could pay down the negative equity -- plus some cushion for future depreciation -- and refinance the existing loan at, say, an 80% loan to value.

Even if the government-sponsored enterprises started with just their own portfolio, that would be a huge step in the right direction. For loans owned by banks and in securities, Fannie and Freddie could pay off the mortgage at the outstanding balance, forgive the necessary principal and write a new loan.

At this point, the homeowner is free to sell the house at the new, lower market price (price discovery) or go on making the now much-more-manageable mortgage payments.

Shared Equity

Banks could “sell” negative equity to Treasury, sharing any future upside based on each party’s pro rata share of the home’s current value (again, we’re forced to use appraisals because there just is not a better option - yet). When the home sells, the bank and Treasury would participate in any future appreciation. If the home's value continues to slide, the bank is less exposed to the losses.

Bank’s could effectively choose the amount they write off: The more they receive from Treasury, the less upside exposure they retain. On the flip side, stronger banks would be able to write off just enough to stay afloat without losing future earnings potential.

The U.K. is already trying a version of this program.