Fed chief: Mortgage crisis to continue - East Valley Tribune: Business

Fed chief: Mortgage crisis to continue

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Posted: Tuesday, March 4, 2008 11:18 am | Updated: 9:31 pm, Fri Oct 7, 2011.

WASHINGTON - Federal Reserve Chairman Ben Bernanke called Tuesday for additional action to prevent more distressed homeowners from falling into foreclosure.

"This situation calls for a vigorous response," Bernanke said in a speech to a banking group meeting in Orlando, Fla.

Even with some relief efforts under way by industry and government, foreclosures and late payments on home mortgages are likely to rise "for a while longer," Bernanke warned.

Rising foreclosures threaten to worsen the problems in the housing market and for the national economy, which many fear is on the verge of a recession or in one already.

"Reducing the rate of preventable foreclosures would promote economic stability for households, neighborhoods and the nation as a whole," Bernanke said. "Although lenders and servicers have scaled up their efforts and adopted a wider variety of loss-mitigation techniques, more can, and should, be done," the Fed chief said.

One of the suggestions Bernanke made was for mortgage and other financial companies to reduce the amount of the loan to provide relief to a struggling owner. "Principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure," Bernanke said.

With low or negative equity in their home, a stressed borrower has less ability - because there is no home equity to tap - and less financial incentive to try to remain in the home, he said.

Bernanke acknowledged this idea might be a tough sell to lenders. Lenders, he said, are reluctant to write down principal. "They say that if they were to write down the principal and house prices were to fall further, they could feel pressured to write down principal again," Bernanke said.

Bill Stevens, chief executive officer of CapitalBank in Greenwood, S.C., said: "We've been talking about it as bankers. It's a tough business decision."

Still, Bernanke suggested such longer-term permanent solutions may work better than shorter-term and temporary ones, where the distressed homeowner could find himself in trouble again. "When the mortgage is `under water' a reduction in principal may increase the expected payoff by reducing the risk of default and foreclosure," he said.

To date, permanent home mortgage modifications that have occurred have typically involved a reduction in the interest rate, while reductions of the principal balance of the loan have been quite rare, he said.

"Measures that lead to a sustainable outcome are to be preferred to temporary palliatives, which may only put off foreclosure and perhaps increase its ultimate costs," Bernanke said.

Lenders last year were on pace to initiate roughly 1.5 million home foreclosure proceedings, up from an average of fewer than 1 million new foreclosures in the preceding two years, the Fed chief said. More than one half of the foreclosures started in 2007 were on subprime loans given to borrowers with blemished credit histories or low incomes.

The housing collapse dragged down home values, especially clobbering these subprime borrowers. Many were left with mortgages that exceeded the value of their homes. They were further socked by low introductory rates on their adjustable mortgages resetting to higher rates, making their monthly payments difficult or impossible, to afford. Problems in the credit markets have made refinancing a mortgage harder.

This year, about 1.5 million loans - representing more than 40 percent of the outstanding stock of subprime adjustable-rate mortgages - are scheduled to reset to higher rates, Bernanke said. The Fed estimates that the interest rate on a typical subprime ARM slated to reset in the current quarter will increase to about 9.25 percent from just above 8 percent. That would raise the monthly payment by more than 10 percent, to $1,500 on average, he said.

Declines in short-term interest rates and a Bush administration-promoted initiative involving rate freezes will "reduce the impact somewhat, but interest rate resets will nevertheless impose stress on many households," Bernanke said.

On Capitol Hill, a number of measures have been offered to help stressed homeowners.

Overhauling the Depression-era Federal Housing Administration, which insures mortgages for low- and middle-income borrowers, could help, Bernanke said. He also called for strengthened supervision of mortgage giants Fannie Mae and Freddie Mac.

Bernanke, who last week signaled that the Fed stands ready to lower a key interest rate again, did not talk interest rate policy in his speech or in a brief question-and-answer session afterward. The Fed, which has been slicing rates since September to help the economy, is expect to reduce them again on March 18, the Fed's next meeting.

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