Even with some relief efforts under way by industry and government, foreclosures and late payments on home mortgages are likely to rise "for a while longer," Bernanke warned.
Rising foreclosures threaten to worsen the problems in the housing market and for the national economy, which many fear is on the verge of a recession or in one already.
"Reducing the rate of preventable foreclosures would promote economic stability for households, neighborhoods and the nation as a whole," Bernanke said. "Although lenders and servicers have scaled up their efforts and adopted a wider variety of loss-mitigation techniques, more can, and should, be done," the Fed chief said.
One of the suggestions 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," Bernanke said.
Bernanke acknowledged this idea - which goes beyond the stance staked out by the Bush administration - might be a tough sell to lenders. Lenders, he said, are reluctant to write down principal. "They say that if they were to write down the principal and house prices were to fall further, they could feel pressured to write down principal again," Bernanke said.
Bill Stevens, chief executive officer of CapitalBank in Greenwood, S.C., said: "We've been talking about it as bankers. It's a tough business decision."
Tom Loonan, vice president of the State Bank of Easton in Minnesota, suggested that debt relief for some who got in over their heads may anger others, who took out mortgages that they could afford. "There's going to be some animosity," he said.
Still, Bernanke suggested such longer-term permanent solutions may work better than shorter-term and temporary ones, where the distressed homeowner could find himself in trouble again. "When the mortgage is under water, a reduction in principal may increase the expected payoff by reducing the risk of default and foreclosure," he said.
On Wall Street, anxious investors pulled the Dow Jones industrials down 45.10 points.
To date, permanent home mortgage modifications that have occurred have typically involved a reduction in the interest rate, while reductions of the principal balance of the loan have been quite rare, he said.
"Measures that lead to a sustainable outcome are to be preferred to temporary palliatives, which may only put off foreclosure and perhaps increase its ultimate costs," Bernanke said.
Brookly McLaughlin, spokeswoman for the Treasury Department, which has been leading the Bush administration's relief efforts, noted that foreclosures are expensive for both lenders and homeowners, giving parties an incentive to renegotiate a mortgage contract. However, "we're not going to dictate how those renegotiations should be accomplished," she said. "If lenders find that in some cases a principal writedown is less costly than foreclosure, then that is an option they have the incentive to consider."
More than half of the projected 1.5 million home foreclosure proceedings started in 2007 were on subprime loans given to borrowers with blemished credit histories or low incomes.
The housing collapse dragged down home values, clobbering these subprime borrowers. Many were left with mortgages that exceeded the value of their homes. They were further socked by low introductory rates on their adjustable mortgages resetting to higher rates, making their monthly payments difficult or impossible to afford. Problems in the credit markets have made refinancing a mortgage harder.
This year, about 1.5 million loans - representing more than 40 percent of the outstanding stock of subprime adjustable-rate mortgages - are scheduled to reset to higher rates, Bernanke said. The Fed estimates that the interest rate on a typical subprime ARM slated to reset in the current quarter will increase to about 9.25 percent from just above 8 percent. That would raise the monthly payment by more than 10 percent, to $1,500 on average, he said.
Declines in short-term interest rates and a Bush administration initiative involving rate freezes will "reduce the impact somewhat, but interest rate resets will nevertheless impose stress on many households," Bernanke said.
Sheila Bair, chairman of the Federal Deposit Insurance Corp., also said it's important to think long term. "Repayment plans or brief deferrals of payments will not allow us to get past our current problems. They are analogous to kicking the can down the road," she told lawmakers Tuesday.
On Capitol Hill, a number of measures have been offered to help stressed homeowners.
Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee, welcomed Bernanke's call for more action. "It is now clear that we will not be able to avert a more serious and prolonged economic slowdown if we don't address the problem of increasing mortgage foreclosures," Frank said. "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."
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Associated Press writer Travis Reed in Orlando, Fla.,
contributed to this report.
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On the Net: Federal Reserve: http://www.federalreserve.gov/