Bernanke's Call: Aid Homeowners

Fed Chief Asks Lenders To Take Aggressive Steps To Address Housing Crisis
By GREG IP
March 5, 2008; Page A3
from the Wall Street Journal

Federal Reserve Chairman Ben Bernanke, raising the level of urgency in dealing with the nation's housing crisis, called on lenders to aid struggling homeowners by reducing their principal -- the sum of money they borrowed -- to lessen the likelihood of foreclosure, and endorsed a bigger role for the federal government in backing such mortgages.

Mr. Bernanke's call, in a speech to bankers, is an acknowledgement the current focus on reducing homeowner's monthly payments by modifying their mortgage rates doesn't solve the underlying problem: the increasing number of American homes now worth less than their mortgages. It also suggests Mr. Bernanke is willing to advocate more aggressive measures to address the deepening housing crisis than the Bush administration has endorsed.

"The current housing difficulties differ from those in the past, largely because of the pervasiveness of negative equity positions," Mr. Bernanke told the Independent Community Bankers of America in Orlando yesterday. With negative equity, which means a home is worth less than its mortgage, "a stressed borrower has less ability...and less financial incentive to try to remain in the home.

"In this environment, principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure" than reducing the interest rate," he said.

A "potentially important step" to make this happen, he said, is to expand the ability of the Federal Housing Administration to guarantee larger mortgages and mortgages on which the borrower is, or is about to be, delinquent, in effect having the federal government backstop many loans that would otherwise go into default.

Mr. Bernanke has taken an increasingly activist stance on multiple fronts in battling the housing crisis. He has slashed interest rates, backed fiscal stimulus and has positioned himself between congressional Democrats, who want more government resources committed to preventing foreclosures, and the Treasury, which has focused on voluntary steps by lenders such as modifying interest rates on mortgages.


House Financial Services Committee Chairman Barney Frank (D., Mass.) called the speech an endorsement of his own proposal. "It begins with [lenders] recognizing they've lost money," he said. "Once they've done that we think the FHA should facilitate the refinancing."

During the housing boom, many homes were bought with little or no money down because both buyers and lenders bet on additional home-price appreciation to create equity.

Home prices have been declining nationwide for the last year. At the end of 2006, 7% of mortgage borrowers had negative equity, according to First American CoreLogic, a research firm. A report by economists from Goldman Sachs Group Inc. and Morgan Stanley and two academics estimates that proportion will rise to 21%, or 10.5 million households, if home prices fall 15%, as they expect. Assuming an average mortgage balance of $250,000, that would put $2.6 trillion of mortgage debt "under water," the report said.

The centerpiece of the Bush administration's efforts to stem foreclosures is Hope Now, a program under which mortgage servicers and lenders voluntarily reduce or freeze the interest rates of certain subprime borrowers. Mr. Bernanke said as a result, "workouts" of subprime mortgages rose from about 250,000 in the third quarter of 2007 to 300,000 in the fourth quarter, while workouts of prime mortgages rose from 150,000 to 175,000 in the same period. That pace picked up in January, he said.

Robert Steel, Treasury under secretary for domestic finance, declined to specifically endorse Mr. Bernanke's proposal but said it is "one of the tools" for trying to reduce foreclosures. In an interview with The Wall Street Journal, Mr. Steel said the problems posed by the housing crisis are "hard, new things" with no single, obvious solution.

He noted since the Hope Now initiative was announced last fall, the scale of the rate-reset problem has been diminished by Fed rate cuts, which means many mortgages will reset to lower rates than had previously been assumed.

Many outside experts also believe the focus on resets has been misplaced, given that most subprime defaults occurred even before lower teaser rates reset to higher levels.

Reducing the principal rather than the interest rate is a "very different framework for thinking about the problem," said Andy Laperriere, an analyst at ISI Group, a brokerage firm. He said with so many borrowers under water, "any proposal that helps them will be very expensive for either the financial institution or the taxpayer," and a large program would potentially sweep in millions of borrowers who weren't going to default anyway.

Industry reacted coolly to Mr. Bernanke's proposal. The American Securitization Forum, which represents participants in the market for mortgage-backed securities -- pools of mortgages originated and sold by banks and other lenders -- said it had already developed procedures for modifying loans, including through principal reduction. To reduce principal, firms that service MBS pools on behalf of the end investors need "a clear basis for concluding that the related borrower is unable...rather than simply being unwilling" to repay.

Steve O'Connor, senior vice-president of government affairs at the Mortgage Bankers Association, said lenders should consider principal reduction as one way of helping borrowers as long as it is "consistent with obligations" to MBS investors.

Mr. Bernanke said a principal reduction on a mortgage that's greater than the home's underlying value may make the mortgage's actual value greater by "reducing the risk of default and foreclosure."

J.P. Morgan Chase & Co. said in a statement it has "begun to review the feasibility of principal reductions for pooled loans." Any such reduction "must balance the interests of investors...and the borrowers' needs," it said.

--Damian Paletta and Robin Sidel contributed to this article