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Bernanke Urges Banks To Forgive Some Mortgage Debt

Lenders must share the pain, Fed chairman warns

By Mark Huffman
ConsumerAffairs.com

March 4, 2008

In a speech in Florida, one of the states hardest hit by the collapse of the real estate market, Fed Chairman Ben Bernanke told bankers that they – and the nation – would be better off if they wrote off some of the debt homeowners owe.

"Efforts by both government and private-sector entities to reduce unnecessary foreclosures are helping, but more can, and should, be done,'" Bernanke said. "Principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure."

Until now, government officials have urged lenders to lend a sympathetic ear when homeowners have difficulty meeting their monthly payments, which often escalate several hundred dollars a month after resetting from low, "teaser" rates to current market rates. This advice has tended to be general in nature, with few specific courses of action recommended.

Bernanke now appears to be spelling out in unmistakable terms what he expects resolution of the current crisis will require. Mortgage companies, he says, will have to absorb some pain to help end the housing slump.

No equity

In the days of easy, subprime credit, many homeowners took out mortgages with little or no money down. As their low interest rates reset to higher rates, they found they couldn't afford the payments and needed to sell their homes.

But because they have little or no equity in their homes, they have very little wiggle room on price. Walking away and defaulting on the mortgage becomes a very real option since they have almost none of their own money tied up in the house. With homes prices falling in many states, the prospects of being able to sell the homes become even more bleak.

What Bernanke is suggesting is a way for lenders to give homeowners some incentive to stay and tough it out – and in the process stop the wave of foreclosures. He is, in effect, asking lenders to give homeowners some additional equity in their homes. It would be money they could pocket if they lowered the price of the house and found a buyer.

If nothing is done, Bernanke argues, home values will fall below the amount homeowners owe, making foreclosure all the more likely. The vicious cycle will pick up speed as rising foreclosures glut the market and push home prices even lower.

However, that view appears to put the Fed Chairman's views at odds with the Bush Administration. Treasury Secretary Henry Paulson told Bloomberg News Monday that concerns about home values falling below mortgage balances might have been inflated.

"Delinquencies and foreclosures likely will continue to rise for a while longer," Bernanke countered in a speech to the Independent Community Bankers of America.

With further declines in home prices likely, he says bankers would be better off losing a little than doing nothing and risking losing it all.

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