equity positions. with low or negative equity, as i have mentioned, a stressed borrower has less ability ( because there is no home equity to tap ) and less financial incentive to try to remain in the home. in this environment, principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure. lenders tell us that they are reluctant to write down principal. they say that if they were to write down the principal and house prices were to fall further, they could feel pressured to write down principal again. moreover, were house prices instead to rise subsequently, the lender would not share in the gains. in an environment of falling house prices, however, whether a reduction in the interest rate is preferable to a principal writedown is not immediately clear. both types of modification involve a concession of payments, are susceptible to additional pressures to write down again, and result in the same payments to the lender if the mortgage pays to maturity. the fact that most mortgages terminate before maturity either by prepayment or default may favor an interest rate reduction. however, as i have noted, when the mortgage is " under water, " a reduction in principal may increase the expected payoff by reducing the risk of default and foreclosure. in my view, we could also reduce preventable foreclosures if investors acting in their own self interests were to permit servicers to write down the mortgage liabilities of borrowers by accepting a short payoff in appropriate circumstances. for example, servicers could accept a principal writedown by an amount at least sufficient to allow the borrower to refinance into a new loan from another source. a writedown that is sufficient to make borrowers eligible for a new loan would remove the downside risk to investors of additional writedowns or a redefault. this arrangement might include a feature that allows the original investors to share in any future appreciation, as recently suggested, for example, by the office of thrift supervision. servicers could also benefit from greater use of short payoffs, as this approach would simplify the calculation of expected losses and eliminate the future costs and risks of retaining the troubled mortgage in the pool. a potentially important step to facilitate greater use of short payoffs is the modernization of the fha, which i have supported. going beyond the current proposals for modernization, permitting the fha greater latitude to set underwriting standards and

ben s bernanke : reducing preventable mortgage foreclosures speech of mr ben s bernanke, chairman of the board of governors of the us federal reserve system, at the independent community bankers of america annual convention, orlando, florida, 4 march 2008. the original speech, which contains various links to the documents mentioned, can be found on the us federal reserve system ’ s website. * * * over the past year and a half, mortgage delinquencies have increased sharply, especially among riskier loans. this development has triggered a substantial and broad - based reassessment of risk in financial markets, and it has exacerbated the contraction in the housing sector. in my remarks today, i will discuss the causes of the distress in the mortgage sector and then turn to the key question of what can be done in this environment to reduce preventable foreclosures. although i am aware, as you are, that community banks originated few subprime mortgages, community bankers are keenly interested in these issues ; foreclosures not only create personal and financial distress for individual homeowners but also can significantly hurt neighborhoods where foreclosures cluster. efforts by both government and private - sector entities to reduce unnecessary foreclosures are helping, but more can, and should, be done. community bankers are well positioned to contribute to these efforts, given the strong relationships you have built with your customers and your communities. the rise in mortgage delinquencies and foreclosures mortgage delinquencies began to rise in mid - 2005 after several years at remarkably low levels. the worst payment problems have been among subprime adjustable - rate mortgages ( subprime arms ) ; more than one - fifth of the 3. 6 million loans outstanding were seriously delinquent at the end of 2007. 1 delinquency rates have also risen for other types of mortgages, reaching 8 percent for subprime fixed - rate loans and 6 percent on adjustable - rate loans securitized in alt - a pools. lenders were on pace to have initiated roughly 1 - 1 / 2 million foreclosure proceedings last year, up from an average of fewer than 1 million foreclosure starts in the preceding two years. 2 more than one - half of the foreclosure starts in 2007 were on subprime mortgages. the recent surge in delinquencies in subprime arms is closely linked to