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Fed Chief Seeks Greater Effort To Stem Foreclosures

Eroding housing market affects overall economy, he warns

May 6, 2008

In a speech to the Columbia Business School, Bernanke signaled approval of a proposal for the Federal Housing Administration to begin refinancing mortgages in danger of default. Democrats in Congress have proposed legislation that would include that step.

He also reiterated his call for lenders to write down a portion of troubled loans, to help homeowners avoid foreclosure.

"In some cases, when the source of the problem is a decline of the value of the home well below the mortgage's principal balance, the best solution may be a write-down of principal or other permanent modification of the loan by the servicer, perhaps combined with a refinancing by the Federal Housing Administration or another lender," Bernanke said.

"To be effective, such programs must be tightly targeted to borrowers at the highest risk of foreclosure, as measured, for example, by debt-to-income ratio or by the extent to which the mortgage is underwater," he said. "Finding the right balance -- particularly the need to avoid programs that give borrowers who can make their payments an incentive to default -- is difficult. But realistic public- and private-sector policies must take into account the fact that traditional foreclosure avoidance strategies may not always work well in the current environment."

Bernanke said many foreclosures are not preventable. He said investors, for example, are unlikely to want to hold onto a property whose value has depreciated significantly, and some borrowers -- perhaps because they were put into an inappropriate loan or because personal circumstances have changed--cannot realistically sustain homeownership.

"However, if a foreclosure is preventable, and the borrower wants to stay in the home, the economic case for trying to avoid foreclosure is strong," Bernanke said.

Because foreclosures impose high costs, including legal and administrative costs as well as the costs of leaving the property vacant for a possibly extended period, he said both the borrower and the lender usually are better off avoiding foreclosure.

Clusters of foreclosures can destabilize communities, reducing the property values of nearby homes, and lower municipal tax revenues. At both the local and national levels, foreclosures add to the stock of homes for sale, increasing downward pressure on home prices in general.

Bernanke's concern is that an escalation in downward pressure on home prices could have an adverse impact on the broader economy and, through their effects on the valuation of mortgage-related assets, on the stability of the entire U.S. financial system.

"Thus, finding ways to avoid preventable foreclosures is a legitimate and important concern of public policy," Bernanke said.

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