Bernanke: More mortgage, home woes ahead

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NEW YORK (CNNMoney.com) -- Mortgage delinquencies and foreclosures will continue to rise for a while longer and further declines in house prices are likely, Federal Reserve Chairman Ben Bernanke said Tuesday.

In a speech to the nation's community bankers, Bernanke said the imbalance between supply and demand for homes on the market will continue to eat into prices, which in turn will lead to additional reductions in homeowner's equity. He said the reset of adjustable rate mortgages higher will also contribute to the problem.

Bernanke detailed a number of steps being taken to limit home foreclosures, including counseling and adjustments of loan rates. But he concluded his speech by saying that "although lenders and servicers have scaled up their efforts and adopted a wider variety of loss-mitigation techniques, more can, and should, be done."

One proposal he endorsed, floated last month by the Office of Thrift Supervision, is that bankers be willing to reduce the principal that troubled borrowers owe on the loans, rather than simply freezing or reducing interest rates. The lender would receive a warrant for the amount that the mortgage's loan balance is reduced, with the understanding it would only be paid with the proceeds of a sale at a higher price than the current depressed value.

Bernanke said with the falling home values and many homeowners owing more on their homes than the home is worth today, there's limited incentive for a homeowner to try to stay in a home without that kind of relief.

Restoring equity. "In this environment, principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure," said the Fed chairman.

He said lenders and those who own the securities backed by the at-risk mortgages are likely to lose more through the foreclosure process than they would through reducing what homeowners owe.

"A recent estimate based on subprime mortgages foreclosed in the fourth quarter of 2007 indicated that total losses exceeded 50% of the principal balance, with legal, sales, and maintenance expenses alone amounting to more than 10% of principal," Bernanke said. "With the time period between the last mortgage payment and...liquidation lengthening in recent months, this loss rate will likely grow even larger."

And he said that the warrants proposed under the OTS plan could help lenders recover some of the reduction in principal at some point in the future.

"The fact that many troubled borrowers have little or no equity suggests that greater use of principal writedowns or short payoffs, perhaps with shared appreciation features, would be in the best interest of both borrowers and lenders," he said.