An example of why principal reductions are inevitable in hard hit markets
Let's say you bought a median priced home in the West Palm Beach market in December 2005, around the peak of the market. It would have cost you $408,200 at the time, according to Florida Association of Realtors figures available here). Let's be generous and assume you put 10% down, rather than finance with some 80/20 scheme. You would have had to cough up $40,820 and finance $367,380 -- leaving you with a mortgage with an initial LTV of 90%. Thirty-year fixed rates were around 6.3% at the time, so your payment (principal and interest only) would have been $2,273.98.
As of December 2008, just three years later, the median price of a West Palm Beach home is $246,000 (again, going from FAR data that's available here). That means your home would have lost $162,200 in value, or 39.7%. During that same three-year period, you would have only paid your mortgage principal down to $353,738.60 (about $13,600, or 3.7% of the original balance).
You would have $54,461.40 in equity, or a 13.3% equity position, assuming the original home did not lose or gain any value in the interim. Stated another way, your LTV would have declined to just under 87%, and the new Fannie/Freddie 105% LTV break would give you some relief.
But as I said earlier, prices haven't stayed the same. They've plunged almost 40%. That means you now have a mortgage with an LTV ratio of 143.8% (!) As you can see, even a more generous 105% LTV limit doesn't help you refi in a market like this one. And a $5,000 subsidy over five years doesn't do much to offset a $162,000 decline in value, much less incentivize you to stay put. This is why principal cramdowns/reductions are all but inevitable in hard hit markets -- Florida, California, and so on.
Oh and by the way, any guess how long it would take to get back to even (your original purchase price) on this hypothetical house -- assuming prices instantly turn around and rise 5% per year from the December 2008 level? Give up? More than 10 years. Your West Palm Beach house would finish 2018 at just under $401,000 and 2019 at around $420,700.