If the government could spend hundred of billions to save the banks, Fannie Mae, Freddie Mac, the automakers, etc. wouldn't it have been better for the economy if the government had paid off everyone's mortgage? That would have recapitalized the banks and removed the debt burden from people - and thus giving them more money to spend.
Could it be done? Yes, it could, subject to local law.
A variant of such an approach has been suggested for those countries experiencing collapse of demand. One might consider whether whether it applied to secured loans (such as mortgages), unsecured loans, or both; whether it would be capped at a certain absolute (say £100k) or proportional (first 50%) of each mortgage; whether it would cover first homes only, or all homes; and so on. These details would radically change the feasibility and consequences of any such intervention.
See the related question: https://economics.stackexchange.com/q/146/104
Such a policy of debt cancellation would have several consequences beyond initial stimulation of demand, that would need additional policies to deal with them.
The resultant surge in demand would, in the absence of any other intervention, result in a massive surge in inflation.
There are some interesting questions about whether this burst of inflation would be a one-off, or not. One could make an argument that as housing has become much more affordable (at least for home-owners), it would increase the downward pressure on wages, which would be in itself counter-inflationary in the medium-long term.
Nevertheless, it would be injecting much more money into the economy than has been seen in QE to date, so the risks would be of extraordinarily high inflation, which might or might not get entrenched. In order to manage the short-term risk, and long-term inflation expectations, it might be necessary to incorporate a lot of tightening, either fiscal (higher taxes and/or lower public spending), or monetary: (higher interest rates, unwinding QE, new requirements for higher core capital for banks)
There are risks of moral hazard for individuals: however, as a society, we were prepared to accept the moral hazard for financial institutions and their staff, so that may or may not be an issue: it is likely to be a question of long-term expectations. If the expectation is that this is at most a once-in-a-lifetime occurrence, then the consequential risk from moral hazard ought to be lower.
Excess profits to lenders
Lenders will typically work on the basis of a certain proportion of defaults, so paying off all loans effectively gives them an artificial boost to their profits.
Worsening balance of payments
There is to a degree a prisoners' dilemma facing nations here. Pressing the reset-button on personal debt across many of the countries experiencing demand-collapse would benefit all of them. However, if just one such country were to do it alone, they alone would increase domestic demand, resulting in a large increase in imports, but no significant increase in exports.
Just looking at the practicality: Because the total value of outstanding mortgages in the US is about $10 trillion, and the government can't afford it without printing enough money to cause hyperinflation. The cost of saving the banks was actually much less than the "hundreds of billions of dollars" that is quoted, because most of it was loans that have been or will be repaid, not cash payments.
Interestingly, ancient Judaism and Christianity held a Jubilee year every 50 years in which all debts were forgive, slaves were freed, etc.
"The land must not be sold permanently, for the land belongs to me. You are only foreigners, my tenant farmers." -Leviticus 25:23
Jubilee would more resemble "the government declares all mortgages and credit card debts void" with FDIC caping the payouts when banks fell into receivership, not simply "the government pays off all mortgages". Yet, it still demonstrates that primitive societies employed tools similar to what you describe.
There is surely all manor of interesting analysis of the economic impacts of Jubilee by Jewish religious historians. You might even find arguments that communism was invented because Western Judeo-Christian societies abandoned Jubilee.
As an aside, I'm surprised that nobody here directly discussed the velocity of money. If you wipe out a mortgage, you might convert a spender into a saver, especially during a recession, meaning you've injected slow money. Conversely, anyone too poor for a mortgage probably spends all their money, meaning giving them a job injects faster money. In addition, it's much cheaper to hire tons of poor people to do useful things, like repairing bridges.
Government purchases of mortgages simply transfers the debt burden from households to the sovereign. Taxes pay sovereign debt (65% of whom are homeowners anyway). No debt has been restructured -- it's now paid via taxes instead of monthly mortgage payments -- and those paying include persons who responsibly avoided housing speculation.
The U.S. has a debt-to-GDP ratio just shy of the critical point of 90%. Purchasing $10 trillion in mortgage debt (about a year of GDP) would put the U.S. on an inexorable path towards insolvency and inflation. There are all sorts of other risks (loss of a risk-free asset, moral hazard, nationalization of the housing industry, etc.) but this should make the point clear that it's not a good idea.
There are only three ways to reduce debt: 1) default, 2) restructure, or 3) lower the real debt burden by de-valuing currency in which the debt is denominated.
I think Energy and Mike point out the some serious issues but the prospects for the futures also need to be considered.
If the banks no longer have those loans then they need to rebuild their income base that is wiped out by the payoff of their loans. They would be incentivised to make a large number of loans so that they could quickly reestablish their base so they can maintain profitability. This is likely to lead to more poor lending practices that lead to this location in the first place.
The high earning heavily leveraged would benefit far more from this than the poor. A function of income is that as it increases the ability to leverage increases in a non lineal fashion. So single person making 250k a year(the benchmark set by the current administration) with a 2 million dollar mortgage(probably underwater currently) on a home would benefit much more than a family of 4 making 50k a year with a 100k mortgage.
Assuming that government does pay off all mortages now people can sell of their now fully paid homes for less than their value, as its basically free money, leverage that money to move into a better home, so home values actually crash, in some areas as people sell them off cheap, people try to gamble on cheap houses(like we just saw), etc. It takes a market that is on the verge of recovery and stabilization and shakes it up. How long before it stabilizes again would be a matter of debate but I would not expect to see it in less than a decade. Business and the Economy thrives on stability and retreats from instability. So while this would appear to be an injection to the economy the chaos it creates would likely actually severely retard future economic growth.
TARP was ~$475 billion of loans to institutions. Loans that are to be paid back, with interest (albeit very low interest). A significant percentage of the TARP loans have been (or will be) paid back. So, the final price tag of the TARP was only a few $billion (pretty low considering the scale of the program).
There is ~$10 trillion in mortgage debt outstanding. That's a much higher price tag than TARP. Secondly, paying off the mortgages = no repayment to the government as there was with TARP. The initial price tag of your plan would be ~$10 trillion, instead of a few $billion.
Furthermore how does a government with >$15 trillion in debt already come up with an extra ~$10 trillion to pay off people's mortgages? Should the government go deeper into debt? Print more money and trigger inflation?
(Note: Some people like to talk about a "secret bailout" by the Fed, implying that the true cost of TARP was much higher than claimed by the government. The "secret bailout" was a series of short-term low/no interest loans to banks. Because they were loans, which were paid back, my point still stands.)
Some other issues to consider:
Remember that the principal balance of your mortgage is only a small portion of your payments to the bank. Over 30 years, you pay a lot of $$$ in interest to the bank (that's how banks make a profit). Banks are expecting that revenue, and it is factored into their financial projections. If those revenue streams suddenly disappeared, I expect it would majorly screw the up the financial industry.
Many people bought houses during the real estate boom, when housing prices were inflated far beyond the "real" value of the house. Is it right to overpay for these houses? This rewards the banks for accepting the inflated value during the appraisal process. (Loan modification forces banks to accept the "real" value of the house.)
The financial crisis was triggered by people buying houses they could not afford. Should they be rewarded with a free house for making poor financial decisions?