When Ben Bernanke Speaks …

03/10/2008

NY Times Editorial
Published: March 9, 2008


In a speech last Tuesday, the Federal Reserve chairman, Ben Bernanke, observed that the upsurge in mortgage delinquencies is closely linked to falling prices, which have left many borrowers owing more on their houses than they are worth. With little or no home equity, he noted, borrowers cannot refinance, which means higher payments for those who have adjustable-rate mortgages. The result, all too often, is foreclosure — especially given the added strain of today’s higher prices for food and gasoline and a contracting job market.

Mr. Bernanke’s recognition of reality set off a tempest because the best way to help “underwater” borrowers who are in danger of default is to reduce the principal balance on their loans. That helps restore equity to the borrower, and is exactly what Mr. Bernanke suggested.

Lenders do not like that approach. They prefer temporary repayment plans and, less frequently, reductions in the loan’s interest rate, neither of which is as effective in these cases. Lenders fear that a manifest need for principal reductions strengthens the case for allowing hard-pressed borrowers to have their mortgages modified in bankruptcy court, which is currently not allowed.

Those courts routinely reduce principal on other loans and could accomplish the task efficiently. So for lenders, who do not want to recognize their losses and do not want to lose control of the process that lets them postpone that reckoning, allowing homeowners to turn to bankruptcy court is anathema.

Mr. Bernanke did not mention amending the bankruptcy code. But he did suggest creative ways that principal reductions could be combined with possible government assistance. For example, a lender could reduce a borrower’s principal to a level that could qualify for a loan from a reinvigorated Federal Housing Administration. Or, a lender who agreed to reduce a borrower’s principal could become eligible to share in any future profit from selling the house, an idea broached by the Office of Thrift Supervision.

The worthy goal is to help troubled borrowers, and in so doing, avert harm to the economy and the financial system. But Mr. Bernanke’s proposals are unlikely to work, because they are based on the notion that lenders and everyone else in the mortgage chain will act voluntarily. That has been tried and has not worked in any way that reflects the nature or scale of the problem.

What is needed is a prod for lenders to reduce the principal balances of underwater homeowners who cannot pay. That prod is to amend the bankruptcy law so that borrowers can have their mortgages modified by the court. Senate Republicans recently blocked attempts to debate a good bankruptcy amendment bill, but Democrats have said they will try again. The bill is intelligently drafted to spur lenders to act before a homeowner files for bankruptcy. If they continued to balk, the court could take over.

It is past time to try something that has a real chance of working. Mr. Bernanke laid out the problem. Congress should act accordingly.