Bernanke to banks: Get real, reduce loan amounts

Good morning. Before you tee him up like a Titleist, give the Fed chairman some credit this morning: he acknowledged the elephant in the room, the one no one else in Washington wants to talk about.  Bush, Obama, Clinton, Paulson -- none of them has faced the facts on this one.

The elephant is this: aided by incompetent lenders, many hundreds of thousands of recent homebuyers borrowed too much, paid too much for their homes, and can't possibly pay back the amount they owe. It doesn't matter if you freeze or reduce the interest rate, or lengthen the mortgage to 40 or 50 years, they can't pay the money back. If banks really want to stop the foreclosure train, Bernanke said today, it makes sense for them to take a deep breath and to reduce the principal on some of these loans.

The AP: "The Federal Reserve chairman, Ben S. Bernanke, called Tuesday for additional action to prevent more distressed homeowners from falling into foreclosure. ... One of the suggestions Mr. Bernanke made was for mortgage and other financial companies to reduce the amount of the loan to provide relief to a struggling owner. 'Principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure,' Mr. Bernanke said."

This is a tough one, bound to be unpopular. Banks and lenders, who presumably know whether this is a smart course of action, appear to be hoping for the tooth fairy instead -- a bailout that won't hurt as much as write-downs would.

Write-downs would also infuriate some of the neighbors -- why do the Wilsons get a special break so they only have to pay $350,000 for their house, but we still have to pay $500,000 for an identical house?  E-mailer JG writes, "This is the most sickening suggestion I've ever heard.  If I understand him, he is saying 'Go ahead and buy something you can't afford and the person who lent you money to buy it should just cut the amount you owe.' ...  Why work hard to achieve anything in this country?  The greedy and stupid people will be rewarded, and the hard-working people that save and live within their means will be punished."

Bernanke knows this kind of backlash is coming: "... we want to help borrowers in trouble, but we do not want borrowers who have avoided problems through responsible financial management to feel that they are being unfairly penalized."

Read the whole speech here and let me know your thoughts. E-mail story tips to peter.viles@latimes.com.
Photo Credit: Bloomberg News.

Comments

[sick of fixin fools]

How to fix...everybody, not just some, but everybodys loans arereduced by.oh lets say 30%. Then all interest rates are max at 5%. That would be fair to the rest of us who were not smart enough to buy something we cannot afford then actually be responsible enough to pay back the loan. I owe 300k, my home is worth 250k, my last refi to 300k was with an apparasil for 400k. I did a refi with a 75% LTV. Let me go back in time and I will gladly take the full refi at 400k now that I know by biting off more than I can chew I will be rewarded for that.

[erinkeenan]

i personally have nothing but sympathy for ben bernanke. he has been thrust into a ginormous mess that was most definitely not of his own making. clearly the fed has realized that they don't have the ammo to do anything to stop what's going on. obviously this is a very troubling idea, principle reduction, but the fact is for the people who bought responsibly, they are going to have to accept that values have to come down and better sooner than later. the market is going to remain frozen if prices don't fall more than they have, and they have not realigned yet with affordability. what's the point of raising the jumbo loan limit if no one's income qualifies for a jumbo? how many people make enough to reasonably qualify for a jumbo?
ok, now im wandering all over the map.
all i say is, give ben a break! looking for someone to blame - i say greenspan's your guy.

[Hula Girl]

'Principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure,' Mr. Bernanke said."

Duh. Now I get it: Restore equity, use home as ATM machine again, spend equity on stuff to keep the economy going, lose equity, have Feds restore equity again.

Repeat until everyone is in delinquency and foreclosure. Then invest in storage units - America's new second home.

For this I pay taxes?!!

[arroyogrande]

"why do the Wilsons get a special break so they only have to pay $350,000 for their house, but we still have to pay $500,000 for an identical house?"

Even better...you and your neighbor buy identical houses in 2003, say for $400,000. You get either an ARM, or a fixed rate loan that you can afford.

Your neighbor, on the other hand, gets an Option-ARM, and only pays half of what you do each month, the remainder getting added to the amount he owes on the house. He spends the amount he would be paying on vacations, dinners out, and expensive car payments. Additionally, he incrementally withdraws "equity" over those four years, using *that* money to pay for more vacations, jet skis, yet another new car, dinners out, cosmetic surgery, and an "investment" in a vacation condo. He ends up owing $600,000 when all is said and done.

Prices drop, houses are selling for $400,000 again, and he appears to be "underwater" by $200,000.

Foolish you. He gets his debt forgiven down to $400,000 again...almost the same as you, who had been living within your means, and not taking on $200,000 in additional, consumer spending related debt.

Next time, you know what you should do. Living frugally and responsibly is for chumps.

- arroyogrande

[CD]

I agree with erinkeenan , Greenspan put us in this mess.
Anyway, nice try Bernanke ,but , if it would happen there would be a revolution in this country, I'll stop paying my credit cards asking for a discount and would asked for a reduction on my car loan. MORAL HAZARD. How many times can we say it. Why don't we teach our kids in school, behave badly and you will be rewarded hundred times fold.
Let it rip, it's over.....I hope you guys are FDIC insured and are out of the financial stock.

[AmericansforPersonalResponsibilty4Obama]

Why work hard to achieve anything in this country?

Someone actually asked that? You mean, there is someone out there that hasn't given up on that notion completely by now????

There is still hope.

[sid]

I like John Reich's(?) idea where the lenders refi/reduce the monthly and the lenders become partners with the homeowners. If the house sells for more than the principle in the future can be used to pay the lender's loss.

In the meantime, the lender gets something every month from the homeowner and deduct the loss.

The homeowner gets to stay in his house.

I imagine there's a lot of details to work out and this will only work if the homeowner is truly committed to living in his house.

[la voce bella]

I used to think Ben Bernanke knew his stuff. I hope this is just election year rhetoric coming from him because if banks do this ridiculous thing, I'll be priced out of the market yet again because home prices will not be declining as they should be. Isn't this supposed to be a free market that creates the incentives for worthy borrowers to invest and LIVE IN their homes?

He should be working on strengthenng the dollar and keep his mitts off the housing market. I am SO depressed!!

[Cal]

Bondholders can hedge, homeowners cant. I could buy insurance on my mortgage portfolio against defaults. I cant buy insurance against me buying a home I cant afford.

Many of the bonds have hedged, they will get paid regardless, I dont think they are that motivated to reduce principal when all it will do is lose them money.

[the problemwithcaring]

On CNBC this morning, someone asked a question about the "fairness" of a proposal like this and one of the panelists actually said something to the effect that - capitalist markets have little to do with "fairness."

I thought that a novel take on the current business environment. In the modern global financial world order, we're all a third world market.

[BottomFisher]

Uncle Ben translation: Not my job mon. IMO somebody has to take the losses from overpaying for homes in this classic bubble. Lets see, will it be home A the home buyers or B the lenders or C the taxpayers......we all know where A and B want it to fall on...if they can't pull that off over our dead taxpayers bodies then A and B will have to duke it out, as per their written legal binding contracts, until its finally over and affordable prices become reality. Then it will be a normal market again. There...not so complicated after all. Class dismissed.

[Daniel]

Why would banks want to do this? It is taking a certain loss against a possible loss. If the banks hang in there they will have a certain number of foreclosures and delinquent borrowers, okay, but if they offer an immediate 25% or 30% principal forgiveness plan, could that not be worse than just waiting to see who is going to foreclose? The eventual foreclosure numbers might not be eqivelent to 30% of their total paper.

I'm not supereconomist, but it seems to me if I was a bank and I had ten guys that owed me 10 bucks, I would rather take the risk that one or two of them might default than just immediately offer them all 2 bucks back.

D

[Tombstone Realty]

I'm not so sympathetic to Bernanke, only because he's made a couple of glaring mistakes - first, dismissing this whole situation as being "subprime" only. He was either lying, or just made that comment up without looking at the data. Now a year later, he's talking about bank failures.

There's also a consistent denial at the Fed as to what counts towards inflationary pressure. Fuel powers *everything* in this market, and any price rise in fuel naturally spills into everything else. They are idiots for excluding it.

Maybe he thought just adding a bit of paint to the place would make the position good enough to flip to someone else once the Bush Administration was over. But while Greenspan is mostly to blame, the rest of the Federal Reserve can't get away scott free.

Neither can Congress. It's insulting to my intelligence that the Banking Committee complains to the fed chairs about their lax regulations, when Congress wasn't making sure the fed chairs were doing their job.

Wholesale dishonesty and corruption, from top to bottom. Whether you were a home 'buyer', an agent, a broker, or a bank CEO.

All we're doing is thrashing around in a web, and waking up Mr. Spider for dinner.

[Chris Young]

This is what you call "perverse economics". What ever happened to Personal Accountability?

Who is going to bail out the banks? Who will "write" their loan down?

The buck has to stop somewhere. Let it fall on those who are responsible for this mess. Otherwise - we are creating a horrifying situation where there is no Personal Accountability for one's actions.

[Fourth Generation]

The problem of over valuation of loans for home mortgages is the one that exacerbated the bubble in housing prices. The write down suggested by Bernanke is DOA because the investors in Wall Street and the banks will never suck up the loss although they should. Also this will also reward stupid and incompetent lenders and borrowers. But willingly or not housing prices must go down to pre-bubble values (may be 2000 values) to have a correction that will place houses within the median country income.

[waitingitout]

I'll give Bernanke this much - that he's willing to even float an unpopular idea to the banking industry shows an independent streak I didn't think he had.

Not that I'm crazy about the idea. At best it's 1/2 right (good for irresponsible borrowers, bad for irresponsible lenders). And how much do the banks write down? $50k? $100k?

As long as we're talking writedowns, how about an across-the-board writedown to current appraisal values. And if you STILL can't afford the home on a 30 year fixed, then you have no business being rescued.

Sorry folks, this is AOS. All Options Suck.

[gc67]

This is absolutely the most disgusting suggestion I've heard yet and lets not kid ourselves here - it is not the homeowners that the Fed cares about, it is the BANKS. If the banks agree to this ridiculous proposition and write down the principal balance on these loans, at least they have a shot at keeping borrowers in their houses. That helps avoid the expense of foreclosing and then reselling the house months or years later for pennies on the dollar.
My husband and I went through this back in the early 90's when our house lost half of its value and we couldn't sell it even then. We gritted our teeth, waited it out and my husband delivered pizzas at night so that we could continue to make our mortgage payments. When we were finally above water again we sold and we swore to ourselves that never again would we borrow more money than we could afford to repay. Since that time we have watched our tiny little 1,000 sq ft condo in Signal Hill TRIPLE in selling price - from the mid $100's to over $350K. We knew then that there was a serious sickness going on in this country and it had to end sometime. We rented and waited it out. So now judgement day is here and rather than force the banks AND their customers to DEAL WITH the consequences of their reckless, thoughtless actions, our REPUBLICAN president and his appointed Fed chairman propose a bailout. My taxes are now going to pay for another idiot's cars, vacations, jewelry and whatever else these people bought with their false equity. I would not allow my own CHILD to get away with ducking his responsibilities like this and yet our PRESIDENT thinks that the banks deserve a break. Yeah, OK, how about all those mortgage brokers give back all those BONUSES that they received over the years for these bad loans, take that money and use it to write down the loans. Then, at least, Mr. and Mrs. Fiscally Responsible will not have to pay for other people's STUPIDITY.

[Paul D'Aula]

Actually, "sick of fixin fools" is perfectly on track. By reducing EVERYONE's debt by 30% and taking the writedowns, the banks continue doing business with most of the current crop of customers. The first bank (i.e. Citigroup) that goes bust causes a run on all of them, so why not? That would free up the american consumer and the give everyone wiggle room to spend again. Sure, the market caps of the big banks would be lower - some of them will be owned by Arab and Chinese entities - but hey, it beats the heck out of a $70 loaf of bread.

[GDC]

The more I hear this guy speak, the more I think he's in way over his head. Intead of cutting interest rates to spur more lending activity, he should be encouraging tighter lending standards. There has to be consolidation and failures for banks to get back to equilibrium - there simply isn't the demand to keep some of these fringe banks in business right now. Same with consumers; they are tired of purchasing and tired of being in debt. Stop throwing fuel to the fire.

The faster banks start tightening their belts, insist on 20% down, and insist on fair appraisals for loans, the faster they will reach profitability down the road.

As for principal reduction, Bernake is proving that he has no clue and is out of touch with what's going on (just like Bush). The people that can't pay their loans are DEADBEATS. They never should have been given credit and allowed to buy homes in the first place! They have bad credit scores, stupidly chose option ARMs, and these people generally have no remorse about defaulting.

It's like loaning money to a deadbeat relative; assume that the money will never be paid back because they will always come up with some excuse why they can't. The banks know this. Boy are they in trouble.

[Hugo Dominguez]

These people who find themselves in this mortgage mess are hard working people who tried a chance at the American dream because *banks* were permitting it, promising greater equity growth and ability to refinance after to two years. Hey who wouldn't take that shot. I did! My lender stayed the interest adjustment and I'm happily working my butt off making payments, no foreclosure, no abandoned property. Works great. Except on thing: The house value dropped 125K!. Not my fault. Now what do I do. I don't think I will be able to regain that equity in my life time. Does it make sense to continue to pay this mortgage? Nope. It's cheaper to rent. Unless the lender is willing to reduce the loan amount, I am going to voluntarily foreclose, even though I have the ability to pay the mortgage.

[Lisa]

I'm torn, because on the one hand, I can see how the factions benefiting most from this whole thing are the banks who are making loads of interest from higher priced homes and higher interest rates, so I feel like, yeah they should take a hit. After all, they were the ones who approved these people to buy the homes.

BUT coming from the standpoint of someone who didn't buy something I couldn't afford, that would be irksome because, hey, where's MY free money. Feh.

[CK]

Why doesn't him suggest banks to forgive all loan? That would make him the most welcomed guest in my house as long as I live.

[marty]

Why is the person who took out the loan for which they can not make the payments allowed a pass? Where was the problem: dreaming beyond their means, or not reading the terms of the loan? If they weren't clear about the loan why didn't they ask? Is not understanding the terms of your loan justification for not paying it? How many people honestly thought a market, any market, would forever rise? I find it hard to swallow that everyone who can't pay their loan is a victim of illegal loan procedures. Some maybe, and those criminals should be prosecuted, but ALL? There are those of us out here who were skeptical about the hugely inflated housing prices in this city and did not take out enormous loans that we weren't sure we could pay. Foreclosures are ugly, and tax revenues are down. I don't want my hard earned tax money to go to rectifying other's folly. Maybe the problem is not teaching our children the fundamentals of economics in school so they can avoid this type of massive folly.

[Are You Kidding Me?]

wow! what do i say to my wife and family now? for the past 4 years, i told them that renting is better than jumping into the housing market because people were acting irrationally, that eventually all the yahoos who buy and spend money like there is no tomorrow will go belly up and we can then pick a nice house that would be within our means. "i know," i told them. i am an econ major. i read the wsj. i read the business section of the la times. i followed the housing market on zip realty. heck, even the gov't tells me that i am in the top 1% income earner--albeit at the bottom of the top 1% because i could not afford to put my family in a house in the la market.

now as i am about to enter the market to buy a home for my growing family, our government (my own damn money) is going to bail out those yahoos?! i don't think so.

the market needs to correct itself and the sooner we stop interfering, the sooner the correction will occur. bailing out the yahoos, either through refi, principle reductions, gov't bailouts, etc., will not solve the problem. housing prices in certain markets are way too high and need to come down. foreclosures will drive prices down. foreclosures will be reflected in appraisals....principle reductions will NOT show up in any appraisals.

[fpinpdx]

Long-time reader, first-time poster here. Allow me to echo sentiments that have already been expressed previously, numerous times. I need to vent. Because I am fu&#ing pissed. This huge ball of crap rolling down hill seems to be headed in a direction where it seems ultimately I will lose out, having been relatively conservative and responsible with my house financing over the years. I bought my first house 12 years ago; last year I did what more or less amounted to a lateral move, selling my house and buying in a different part of town. I put all of the proceeds from the sale of the old house into the purchase of the new house; my new loan was at about 50% LTV (naturally the mortgage broker tried to convince me into putting less down). I've always had 30 or 15 yr fixed mortgages; the 3 times I refied my old home's mortgage, I never took money out. I've never had an equity line of credit. And, from savings and a one-time financial windfall a few years ago, I built a small cabin on a piece of land I bought. There is no mortgage on this vacation home. Have the values of my properties gone down since the peak? Yes, of course. Am I able to continue to make my mortgage payments. Yes. Is my lender in jeopardy of losing money on my loan? No. Am I in need of a bailout? No. Will other irrisponsible idiots get a bailout, on their lost equity? Probably. Am I schmuck? TBD.