I would say that there's a variety of views about principal forgiveness within the Federal Reserve System and there is no official position. There seems very likely that principal forgiveness could be helpful depending on how it's structured in reducing delinquencies.

    There are also some potential drawbacks. One of them is the fact that the amount of negative equity in the United States is about $700 billion, which is enormous. And so there's no conceivable program that is gonna put everybody in the country above water.

    And so I think the issue then becomes, if we have $20 billion or $25 billion or whatever the number may end up being in this settlement, you know, what is the most cost effective way to help as many people as possible? And I think that's an ongoing debate.

    But with respect to principal reduction, I've -- you know, I've spoken about this in the past, and it certainly has some advantages.

Further purchases of mortgage-backed securities would in my view help provide a more rapid recovery in housing, by reducing the costs of refinancing or purchasing new homes. Of course, these Fed actions would be even more effective if accompanied by fiscal policies designed to speed the recovery in housing.

I believe that as a country, we need to take this opportunity to rethink many aspects of our public policy programs in the context of housing finance. Home ownership has long been part of the American dream, in no little part because home owners have invested not just in their houses but in their communities. But, through the mortgage interest tax deduction and other programs, we are encouraging people to buy homes by taking on debt—and sometimes large amounts of debt. If we truly want to encourage home ownership, we should contemplate programs that provide incentives for individuals to save and become equity holders in their homes—and, by extension, in their communities.

The extent of Congressional meddling in this market has been astonishing to the point where one can barely identify what the private sector outcomes would be in the absence of intervention.

To the extent possible, we need to let the private sector provide the bulk of U.S. housing finance going forward, without the incentive‐distorting set of government programs and taxpayer guarantees that caused our current system to collapse. Those programs meant well, but ended up costing everyone dearly.

[S]een through the lens of community, however, foreclosure may be viewed as a symptom of broader problems affecting neighborhoods – such as high concentrations of unemployment, elevated crime rates, and poor code enforcement. Let me be clear; I am not saying that “the community is the problem,” but rather that, in this view, different communities will experience problems differently because of their different characteristics, requiring different solutions in many cases. The public policy solution for this problem may be to have more general revenues available for non-profits and local governments to address the problem in a more holistic fashion.

Including rental options among the mix of stabilization strategies makes particular sense at a time of high unemployment. Even in the best of times, homeownership limits mobility in the labor market.

Just as public focus, experimentation, and policy debate have informed best practices with regard to loan modifications, we must also begin the work of developing responsible foreclosure and real estate inventory management protocols. Minimizing the amount of time that properties remain vacant and maximizing the price at which they are sold will serve the interests of both lenders and the communities. At this moment, lenders and communities alike are woefully under-resourced and unprepared for the volume of real estate that will need to be processed.

On the fiscal side, it is possible that Fannie Mae and Freddie Mac could play a more significant role in restoring liquidity and providing a secondary market for mortgages that reflect the lower cost of funds in many credit markets. Further exploration of the GSEs’ options for pricing and programs may result in additional support to the mortgage market.

On the monetary policy side, the Federal Reserve announced on November 25 that it would be buying up to $100 billion in GSE direct obligations, and up to $500 billion in mortgage-backed securities.[Footnote 9] A subsequent announcement on December 30 provided more details.[Footnote 10] Since the announcement of the program, designed to reduce the recently widening rate spreads on GSE debt and on GSE-guaranteed mortgages, mortgage rates have declined (see Figure 8). Some mortgages in Boston are now available for under 5 percent.

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Since stabilizing the housing market is critical, expanded use of policies that address the cost of housing finance may give further impetus for new home buyers and existing mortgage holders to take advantage of what are very low rates by historical standards.

For example, several programs to mitigate the problem of foreclosures and the credit losses precipitated by falling house prices are either in effect or have been proposed. They fall into two broad categories:  those aimed more or less directly at reducing the number of foreclosures by focusing mainly on helping homeowners who are at risk of losing their homes, and those designed to reduce borrowing costs for a much wider population, thereby supporting the overall demand for housing and, hence, house prices.

In the first category is the Hope Now Alliance, a voluntary program that started in October 2007 which brings together counselors, servicers, investors, and other mortgage market participants.  It facilitates the reworking of mortgage loans by marshalling the incentives of lenders and borrowers to avoid the deadweight losses associated with foreclosures. A second example is Hope for Homeowners, a federal program resulting from legislation sponsored by U.S. Congressman Frank and Senator Dodd. This program went into operation at the beginning of this month. It expands the role of the FHA to improve loan “workout options” by providing a government guarantee of payment to lenders. In return, lenders must forgive a portion of the principal to make the new loan more affordable. In addition, the program includes a shared-appreciation feature in which the FHA and homeowner divide both the equity created at the beginning of the new mortgage loan and any future house-price appreciation.

Moreover, expanded versions of such workout approaches have been proposed. In particular, FDIC Chairwoman Sheila Bair has suggested guidelines to target and streamline the loan modification process. She also proposes using loan guarantees authorized by the Emergency Economic Stabilization Act as an incentive for servicers to lower mortgage payments so as to make them affordable and sustainable. 4 Other proposals are modeled on the Homeowners’ Loan Corporation instituted in the Great Depression. 5 The basic idea is that the government would offer to buy under-water loans—now about 15 percent of total mortgages—from lenders and refinance a new mortgage for qualifying homeowners at a lower rate.

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A second category of proposals is aimed at a much broader set of borrowers, and would boost the overall demand for housing by reducing borrowing costs through low-cost government loans or tax credits. 6 They hold the potential to reduce the number of foreclosures and associated credit losses both directly—by reducing after-tax house payments—and indirectly—by providing support to house prices. It is true that house prices do need to adjust, and, until they do so, potential buyers may stay out of the market. 7 However, the concern is that house prices may “overcorrect” for a number of reasons, not the least of which could be today’s extraordinarily tight credit conditions. This overcorrection could have devastating effects on the financial system and the economy, and such programs seek to avoid that outcome.