Things are going to get messy

Yesterday Federal Reserve Chair Ben Bernake gave a speech at Columbia Business School's Annual Dinner. Topics covered in the speech were covered all over the news, one of the best articles on the speech was in Bloomberg titled Bernanke Urges Action to Slow Jump in U.S. Home Foreclosures.

Bernanke, in a speech in New York yesterday, also reiterated his call for lenders to forgive portions of mortgages for some struggling homeowners. He said proposals should be ``tightly targeted'' at borrowers at greatest risk of losing their properties, and avoid providing an incentive for defaults.

The Fed chief also backed the idea of having the Federal Housing Administration refinance troubled mortgages, a concept included in Democratic legislation in Congress, without explicitly endorsing the bill. His remarks indicate a gap with the Bush administration, which has preferred to rely on industry-led efforts.

...Bernanke did note that accelerating foreclosures may push home prices down further, hurting the broader economy and threatening the financial system. He anticipated the foreclosure rate will increase this year after such proceedings began on 1.5 million properties last year.

A quarterly Fed survey yesterday showed the share of banks making it tougher for companies and consumers to borrow approached a record last month in the aftermath of the subprime mortgage collapse. The Senior Loan Officers' Survey found a net 70 percent of banks increased their loan rates over their cost of funds.

In the past, typical approaches to helping homeowners included temporary repayment plans or folding missed payments into the principal balance, Bernanke noted yesterday. That may not work in the current crisis, he said.

``In some cases, when the source of the problem is a decline of the value of the home well below the mortgage's principal balance, the best solution may be a writedown of principal or other permanent modification of the loan,'' Bernanke said.

One option would be for the FHA to refinance a loan after the lender or investor forgives part of the mortgage, he said.

Bernanke warned that ``to be effective, such programs must be tightly targeted to borrowers at the highest risk of foreclosure.'' Qualification guidelines could be set, such as identifying an amount of debt compared with income, or the extent to which the home value is below the mortgage amount, he indicated.

These are going to be very difficult proposals. There is alot of questionable offers and rewarding of bad behaviors in the speech. The Federal Reserves reactionary attitude to the housing crises already is punishing savers and prudent investors. By encouraging the write-downs of underwater loans will just compound issues. This will not encourage sound financial investment. Is there going to be any differentiation between those who have the resources and did not invest them in their homes, versus those that put their money to lower their mortgages. How is it going to divide the liar loans that either were never accurate or with the recession and job losses now inaccurate. What about the investors who claimed the homes would be owner occupied to receive a lower rate. It is Mish's Global thinks that the best course for the government would be to stay out and let the chips fall where they may.

Here is a great final quote from Housing Panic -

Every homedebtor and housing gambler in America now has the incentive to stop paying their home loan, immediately.

People who pay as promised get nothing. No cut in principal. No reduction in interest rate. Nothing.

Some have questioned the need for the measure, saying that it would punish homeowners who played by the rules and didn't overextend themselves.