Mortgage forgiveness proposal

Fed chairman Bernanke has moved beyond the usual monetary policy tactics of cutting interest rate to propose some form a mortgage forgiveness be given by lenders in a speech before the Independent Community Bankers of America Annual Convention, Orlando, Florida.

http://www.federalreserve.gov/newsevents/speech/bernanke20080304a.htm

After describing the current market situation, Bernanke got down to the focus of his current thinking.

This situation calls for a vigorous response. Measures to reduce preventable foreclosures could help not only stressed borrowers but also their communities and, indeed, the broader economy. At the level of the individual community, increases in foreclosed-upon and vacant properties tend to reduce house prices in the local area, affecting other homeowners and municipal tax bases.

In cases where refinancing is not possible, the next-best solution may often be some type of loss-mitigation arrangement between the lender and the distressed borrower. Indeed, the Federal Reserve and other regulators have issued guidance urging lenders and servicers to pursue such arrangements as an alternative to foreclosure when feasible and prudent.

Of course, the words forgiveness was not actually used but a simple NPV argument. If the cost of cutting payments is less than the cost of foreclosure then mortgage bankers should not foreclose. There is general agreement that this will work. The issue is whether legal documents and accounting rules can make this happen easily.

The actual action the Fed can take in controlling the credit adjustment process is limited as stated by the chairman.

The Federal Reserve can help by leveraging three important strengths: our analytical and data resources; our national presence; and our history of working closely with lenders, community groups, and other local stakeholders.

Urging is not very strong action.

I urge the Congress and the GSEs to take the steps necessary to allow more potential homebuyers access to mortgage credit at reasonable terms.

Nevertheless, this is an important speech in setting a tone of what the Fed believes should be done in the housing market.