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Consumers stuck with unnecessarily high debt-service payments cannot free up the cash they need for spending on other things, blocking an important mechanism that in the past helped the economy recover from recessions.

“Easing some of these obstacles could contribute to the gradual recovery in housing markets and thus help speed the overall economic recovery,” the staff paper says. “Some actions that cause greater losses” at Fannie Mae and Freddie Mac — such as an easing of their “putback” policy on defaulted loans — might still “be in the interest of taxpayers if those actions result in a quicker and more-vigorous economic recovery.”

Governors’ ideas

Elizabeth Duke, a Fed governor, last week blamed the housing debacle on credit standards that swung from being too loose during the housing boom to being too tight today as the mortgage industry reacted to escalating defaults.

“Stricter underwriting, higher fees and interest rates, more stringent documentation requirements, larger required down payments, stricter appraisal standards and few available mortgage products” are holding back housing and the economy, she said.

William Dudley, president of the Federal Reserve Bank of New York, warned that the number of foreclosures could nearly double in the next two years, posing a dead weight on the economy and housing market, without more aggressive federal intervention.

He advocated low-cost, streamlined refinancings for all borrowers who have good credit and are current on their loans, a $15 billion “bridge loan” program to help jobless homeowners avoid default, and earned principal reduction for diligent borrowers, among other proposals to break the logjam in housing.

“A more robust housing market matters for the wider economy,” he told New Jersey bankers on Jan. 6. Further federal aid for homeowners will “support growth and make monetary policy more effective.”

While many legislators focus on the costs to taxpayers, Mr. Dudley, a former Goldman Sachs Group Inc. executive, argued that despite some added losses, his proposals are “strongly in the public interest” because taxpayers would benefit greatly from an improved economic performance that generates more jobs and income.

Political reaction

While many Democrats applauded the recommendations, several Republicans in Congress expressed outrage at the Fed’s increased activism on housing. Republicans generally blame Fannie and Freddie for helping to create the housing crisis and oppose getting them further involved in a housing rescue.

Sen. Bob Corker, Tennessee Republican, took offense at Mr. Dudley’s proposal for Fannie and Freddie to reduce principal on some loans that are underwater.

“Reducing the principal on home loans for borrowers who put no money down amounts to a massive wealth transfer from places like Tennessee, where most homeowners have borrowed responsibly, to places like California and New York, where exotic mortgages were widely used to finance a speculative housing boom,” Mr. Corker said. “It is absolutely egregious that the Federal Reserve would insert itself in this manner.”

Sen. Orrin G. Hatch, Utah Republican, said the Fed was “out of bounds” and overstepping its authority in suggesting ways for Congress to spend federal money.

“I share your frustration over the painful adjustments taking place in the housing and housing-finance markets following the bursting of the housing bubble,” he said in a letter to Mr. Bernanke. But he warned that “any hint of activism” on the Fed’s part could jeopardize the central bank’s traditional independence in dealings with Congress.

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