Bernanke's Bold Call

In one stroke, Ben Bernanke, the Federal Reserve chief, has shifted the debate over what should be done about the rising wave of foreclosures.

By urging that lenders consider reducing the principal in negotiations with troubled borrowers to avoid foreclosure, Bernanke is indicating that the efforts led by Treasury Secretary Henry Paulson are not enough.

To be sure, Bernanke did not call for government involvement in the modification of loan terms.

But as Edmund Andrews of the New York Times points out, Bernanke's remarks stand in sharp contrast to recent comments by Paulson.

The Treasury Secretary, Andrew says, has drawn "a clear distinction between helping people who could not keep up with rising monthly payments and helping people who, because of falling house prices, had no equity in their homes."

Bernanke argued that with growing number of homes worth less than the mortgages on them, a principal reduction may be more appropriate.

"With low or negative equity, as I have mentioned, a stressed borrower has less ability (because there is no home equity to tap) 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."

Moody's Economy.com has estimated that 8.8 million homes, or 10.3 percent of the total, are worth less than the mortgage on them. And the number of foreclosures and bank repossessions is growing.

Still, Bernanke acknowledged that lenders would be reluctant to reduce principal in loan modifications. In any case, the securitization of mortgages has made loan modifications very difficult to do.

But by urging a more vigorous response to the housing crisis, Bernanke has entered the political fray.

Fed chairmen usually work very hard to avoid being drawn into partisan debates. Yet Alan Greenspan ended up being seen as endorsing President Bush's tax cuts in 2001 and now Bernanke has in essence given a nod to Democratic lawmakers who are seeking rescue plans that go far beyond what Paulson and the White House have proposed.

Indeed, Representative Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee said of the Fed chief's comments: "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 and they encourage me to believe that we will be able to adopt measures that reflect this approach."

Jeffrey Cane