Should Banks Modify Mortgages?

Speaking to bankers at a conference in Florida today, Fed Chairman Ben Bernanke said that banks should consider lowering mortgage debt for borrowers that are under water. For example if a home’s value has dropped to $300,000 and the mortgage is for $350,000, Bernanke is suggesting that banks lower that loan to an amount that’s compliant with bank underwriting guidelines. In theory this would be cheaper for banks because they’d keep the borrower in the home and paying a lower mortgage … as opposed to all the cost of the foreclosure process and the write-downs that result from the foreclosure process anyway.

The theory is certainly worth considering, but implementation is complicated at best. Using the example above, let’s say the bank only wanted loans up to 90% of value. That would mean lowering the $350,000 loan by $80,000 to $270,000. Under current regulations, that loan would also require mortgage insurance, and it may not have had M.I. before. Maybe it didn’t have mortgage insurance because the $350,000 is comprised of 2 loans each with different lenders who’d be involved in the proposed write-downs.

Foreclosures are already very complicated. With all the complications of how to figure out how Bernanke’s latest proposal might work, it could become more expensive than the traditional foreclosure/write-down process. And this is to say nothing of the anti “bailout” backlash.

Bernanke added: “The fact that many troubled borrowers have little or no equity suggests that greater use of principal write-downs or short payoffs, perhaps with shared appreciation features, would be in the best interest of both borrowers and lenders.”

Perhaps. Or perhaps the pain of traditional foreclosures needs to run its course.