Step away, Mr. Bernanke

Ever since financial markets around the world became engulfed last summer in the subprime mortgage turmoil, the situation has gone from bad to worse as the tumult has bounced from one market segment to another. A familiar refrain in recent months has been: “We’re all subprime now.”

Indeed, according to a recent report by the Hope Now Alliance, the Bush administration-backed group that is co-coordinating the mortgage industry’s voluntary efforts to address the consequences of the housing bubble’s accelerating deflation, prime mortgages (those extended to borrowers with good credit) comprised 43 percent of the loan workouts in January.

The mortgage “crisis” initially afflicted subprime borrowers. In most cases, these were homebuyers who had bad credit histories; who purchased houses far more expensive than they could afford; or who provided little or no income documentation. Many subprime borrowers received adjustable-rate mortgages (ARMs). Falling home prices and the intensifying credit crunch have precluded many borrowers with ARMs — prime as well as subprime — from refinancing before their interest rates increased. The Mortgage Bankers Association reported Thursday that a record 5.3 percent of subprime ARMs entered the foreclosure process during the fourth quarter, while late payments by subprime ARMs soared above 20 percent.

Declining home prices are now causing big problems for prime borrowers who made small down payments. If a $400,000 home was purchased with a 2 percent down payment ($8,000) and if the price of that home has fallen by 15 percent ($60,000), then “homeowner equity” has become a negative $52,000. In real estate parlance, this is known as being “underwater.”

In a speech to bankers earlier this week, Federal Reserve Chairman Ben Bernanke urged them and other mortgage lenders and investors to begin reducing the principal (the amount homebuyers borrowed) for purchasers who now find themselves “underwater” — even if the homebuyer’s predicament is directly linked to his risky strategy of buying a home in a bubbly market with little or no down payment.

Citing forth-quarter data indicating that total losses incurred by lenders who foreclosed subprime mortgages “exceeded 50 percent of the principal balance,” Mr. Bernanke said “loss-mitigation arrangements between the lender and the distressed borrower” would help to prevent “unnecessary foreclosures” that damage both local communities and the national economy. “In this environment, principal reductions that restore some equity for the homeowners may be a relatively more effective means of avoiding delinquency and foreclosure.”

Mortgage lenders and investors know what is in their best interest. They are fully capable of calculating the costs of foreclosure without the help of Mr. Bernanke. The Fed chairman should not be publicly pressuring banks and other lenders to dip into their dwindling capital to rescue people who irresponsibly over-borrowed.