Fed pledges to use all tools to help economy

By Maura Reynolds

Jan. 29, 2009 12 AM PT

WASHINGTON — A new Federal Reserve strategy to limit foreclosures on mortgages it controls could shed light on the contours of a broader plan being developed by the Obama administration to help keep people in their homes.

The new policy, adopted by the Fed without fanfare last week and provided to key lawmakers Tuesday, allows for loan modifications for some troubled borrowers -- possibly including a reduction of the amount owed -- if the mortgage servicer determines that the loss from rewriting the loan would be less than the loss from foreclosure.

Interest in the policy grew as the central bank said Wednesday that it would continue to hold its benchmark interest rate close to zero and to use “all available tools to promote the resumption of sustainable economic growth.”

In a statement issued after its regular meeting, the Fed’s policymaking committee said it still expected an economic recovery to begin “later this year.” But the panel also said there was a significant chance its prediction was premature.

Since the credit markets seized up last year, the Fed has tried to restart them by slashing interest rates as low as they can go, to a range of zero to 0.25%, and by buying financial assets as a way to support lending.

Although the Fed’s moves have helped stabilize the financial sector, economists say the central bank won’t be able to foster a larger economic recovery without massive action by the federal government to address the banking crisis and stem the tide of foreclosures.

The Fed’s policy is notable for its explicit endorsement of write-downs of principal.

The Federal Deposit Insurance Corp. initiated an aggressive loan-modification program at IndyMac Federal Bank, which the FDIC has been running since IndyMac’s failure last summer. The FDIC’s plan permits a reduction of a loan’s interest rate and an extension of its term, but doesn’t allow for principal write-downs.

Bank of America Corp., which acquired Countrywide Financial last year, agreed in a settlement of a court case to offer principal write-downs on certain loans.

The central bank’s policy applies only to mortgages the Fed controls via $74 billion in mortgage-related assets it acquired last year from the collapse of investment house Bear Stearns and from the central bank’s bailout of insurer American International Group Inc.

Those assets represent only a fraction of home loans in distress, but it is likely that the Fed’s policy reflects the direction the Obama administration is looking at to prevent foreclosures, said Dean Baker, a housing expert and co-founder of the Center for Economic and Policy Research in Washington.

“It’s hard to believe that the Fed would go ahead with something that flouted what the Obama administration wanted,” he said. “It’s likely they are thinking along comparable lines, even if not the exact same program.”

In addition, Baker said, the Fed policy by itself would have greater reach if the administration launches a program to buy troubled mortgage assets and gives the Fed a role in managing them.

“Whatever they do with the banks, clearly the Fed is going to have more control over mortgages,” Baker said. “So presumably, this is going to be the pattern.”

Under the Fed’s mortgage policy, a loan can be modified if the servicer determines that the owner of the mortgage would suffer a greater loss from a foreclosure than it would from rewriting the loan.

The Fed said it would give priority to reducing the outstanding balance on a loan in any case where the home’s value has fallen 25% or more. Housing prices have plunged more than 30% in some areas.

To be eligible, a homeowner must live in the mortgaged home, have a verifiable income and be at least 60 days behind on loan payments. A borrower may also apply for a modification before becoming 60 days delinquent by demonstrating an inability to make payments because of a “trigger event” such as an interest-rate reset or a job loss.

President Obama’s new Treasury secretary, Timothy Geithner, reiterated Wednesday that the administration was working on a sweeping program to stabilize the banking sector and address the growing tide of mortgage foreclosures.

“We are putting together what we hope will be a comprehensive plan for helping repair the financial system and bring recovery,” Geithner said as he met with officials overseeing the efforts initiated by the Bush administration to shore up the banking system.

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Walter Hamilton in New York and Peter G. Gosselin in Washington contributed to this report.