Fed chief says mortgage crisis set to continue

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.

Brookly McLaughlin, spokeswoman for the Treasury Department, which has been leading the Bush administration’s relief efforts, noted that foreclosures are expensive for both lenders and homeowners, giving parties an incentive to renegotiate a mortgage contract. However, “we’re not going to dictate how those renegotiations should be accomplished,” she said. “If lenders find that in some cases a principal writedown is less costly than foreclosure, then that is an option they have the incentive to consider.”

More than half of the projected 1.5 million home foreclosure proceedings started in 2007 were on subprime loans given to borrowers with blemished credit histories or low incomes.

The housing collapse dragged down home values, 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 initiative involving rate freezes will “reduce the impact somewhat, but interest rate resets will nevertheless impose stress on many households,” Bernanke said.

Sheila Bair, chairman of the Federal Deposit Insurance Corp., also said it’s important to think long term. “Repayment plans or brief deferrals of payments will not allow us to get past our current problems. They are analogous to kicking the can down the road,” she told lawmakers Tuesday.

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

Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, welcomed Bernanke’s call for more action. “It is now clear that we will not be able to avert a more serious and prolonged economic slowdown if we don’t address the problem of increasing mortgage foreclosures,” Frank said. “Bernanke’s willingness to work with us in a cooperative way, and his outline of the principles that we should be applying are very hopeful signs.”

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