Fed Adopts Program to Stem Foreclosures
Wednesday, January 28, 2009
With its bailouts of Bear Stearns and American International Group, the Federal Reserve took a vast portfolio of mortgages onto its books. Now, it is trying to use its control of billions of dollars worth of home loans to help prevent foreclosures.
The Fed will seek to renegotiate mortgages it owns that might otherwise enter foreclosure, Chairman Ben S. Bernanke told congressional leaders in a letter yesterday. The decision won praise from congressional Democrats, who took it as a sign that the central bank's leaders are cooperating with efforts to use government power to try to stem the number of foreclosures.
It is unclear how many homeowners stand to benefit. Under the program, the Fed can reduce what a homeowner owes on a mortgage, lower the interest rate, lengthen the term of a loan or take other steps to keep a loan from defaulting, if doing so would offer taxpayers a better long-term payoff than foreclosure. Individual borrowers are unlikely to know whether their mortgages are owned by the Fed, but if they qualify for a renegotiation, they would deal only with their mortgage servicer.
The Fed is emphasizing reducing the amount of principal owed by people at risk of foreclosure, particularly those with a loan balance that is more than 125 percent of the estimated value of their property. Private lenders have been reluctant to renegotiate loans that way, as some of the institutions that own those loans, in the form of mortgage-backed securities, stand to lose money and therefore object.
Bernanke has previously advocated principal reductions, saying in a speech in March that they could be an "effective means of avoiding delinquency and foreclosure."
If the Fed strategy works and reduces the number of foreclosures while helping the owner of the loans -- the central bank in this case -- it could serve as a model for other owners of mortgage loans. For example, the Federal Deposit Insurance Corp. has tried to use its control of California bank IndyMac, which it seized last summer, to do loan modifications, but has been frustrated by investors in those loans being unwilling to reduce the amount of principal owed.
"It's a step beyond what FDIC is doing with its own portfolio," said Alan White, an assistant professor at Valparaiso University School of Law, who has been studying the foreclosure crisis. "Principal write-downs are still the critical issue" in keeping borrowers in their homes.
It is impossible, based on public information, to know the exact dollar value of the mortgages the Fed holds -- though it is in the tens of billions of dollars. In the near term, the mortgages affected are those held in special limited liability corporations that the central bank created to hold assets after its March rescue of investment bank Bear Stearns and September takeover of insurance company AIG.
The Bear Stearns portfolio is worth $27 billion, of which some portion -- exactly how much the Fed will not disclose -- consists of residential mortgages. The AIG assets include a $20 billion portfolio of mortgage-backed securities and a $27 billion portfolio that includes complex securities that are partly backed by mortgage debt.
Congressional leaders yesterday praised the Fed's action, while urging further steps. "This is an important advance, and I hope to work with the [Fed] to strengthen the program," said Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee. Dodd also urged the Fed "to work with consumer advocates to develop the most effective program possible."