ARC's 1st Law: As a "progressive" online discussion grows longer, the probability of a nefarious reference to Karl Rove approaches one

Wednesday, March 05, 2008

Federal Reserve Chairman to Lenders - Just Cut the Principal!

Ben Bernanke has gotten mixed reviews on this blog and within the larger media. My biggest beef with him is that every time he opens his mouth, the market tanks. His lack of consistency and his often too direct statements are the worst of both worlds - a Fed Chairman who'll tell you exactly what he's thinking, but you can't bet that his position will be the same from day to day.

Bernanke's recent public discussion included this recommendation to lenders:

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

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 [sic] the current focus on reducing homeowner's [sic] 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.

So, someone takes out a loan with no money down on a home and Bernanke just wants the banks to eat it? He's calling for the lender to hand out a check for $250,000 on a home (valued at $250,000 at the time) and now tell the borrower, "Hey... remember that 250g's you owe us? Let's make it just 200g's and you can pocket the other 50.

The ramifications of such a "solution" are laughable:
  1. borrowers that are currently making their payments and working with their lender to get a reduced rate on their principal will stop those efforts in the hopes that they can get the reduced principal solution and/or refinancing from the FHA (aka the American Taxpayer)
  2. Borrowers will continue to seek out homes that are at or above their maximum limit for housing price, given the possibility of this type of a solution becoming the norm should they start to default
  3. Credit will become even tighter as lenders understand that not only are the rate terms re-negotiable in a static contract, but that they might also see pressure to just write off large portions of the amount borrowed as a loss just for the heck of it. Who would invest in a mortgage industry knowing that the terms of any contract might come under government pressure to be invalidated?

That Bernanke also calls for an increased role of the taxpayer to cover people's gambling home mortgage losses is one reason why I think Ben will be a one-term Fed chairman.

Your Co-Conspirator,
ARC: St Wendeler

Comments (5)
Brian said...

On second reading, I wonder if Bernanke was basically saying that Lender's should accept "short sales" more readily than they may be doing now. If so, then that was probably a 'right' thing to say, but horribly said, which just make things worse than if he had never opened his mouth in the first place!

For those that don't know a short sale is where you tell your lender, that your house isn't worth, on the open market, the amount of the mortgage. So you negotiate with the lender to allow you to sell the house "short" of the mortgage amount, and in exchange the mortgage company agrees to not hold you liable for the difference. As opposed to you just handing the keys over in a foreclosure, where essentially the lender is in the same boat, except they don't have a buyer for the property, and they have to go through he legal ($$$) process to foreclose.

Short sales were always in the cards for the lender, just as foreclosures were, so there's not factor of changing the contract so to speak. It also avoids some of those borrowers hoping for a "free money" solution, since they will have to sell their home.

Still, if thats what Bernanke meant, he's a total idiot and should keep his mouth shut.

St Wendeler said...

Yes, he didn't seem to imply (or recommend) that there would be any sale of the underlying property involved; just a renegotiation of the principal amount.

Brian said...

Thats the only thing that makes any financial sense. My worry is that he really did mean for lenders to renegotiate the principal amount...

In which case he's just an idiot. I want that deal. Allow me to make even more money when the housing market rebounds (as all down markets do eventually) and I eventually sell. That would be "found" money for the borrowers. And TAX FREE too!

Monterey John said...

The alternative could be a sale on the court house steps after the foreclosure, and what would that net the bank?

I admit, it sounds crazy, but as a practical matter, it might not be the worst idea in the world.

Frankly, I think the market should be allowed to correct itself, but this approach might buffer some pretty dire consequences for both the borrower and the lender.

Just a thought.

Brian said...

Except, the lender has so many MORE options. Heck they could defer any payments for a year and still be better off than writing off loan principal from their books.

I understand where Bernanke was trying to go I think. Basically saying things are real bad in the credit market (what else is new) and he's basically saying that he's not going to be able to do enough.

But I can't imagine a public bank being able to write down their principals on loans without massive shareholder lawsuits.

My real fear was that this was a gift to federal lawmakers that want to provide a taxpayer bailout....