March 4, 2008 Bernanke says falling home values are causing turmoil Play video

(NECN) - Strong words Tuesday from the Federal Reserve Chief. Ben Bernanke says the current housing difficulties are likely to continue and get worse. He is warning banks that they need to take action, and now.

In the past year, Florida has had more than double the nation's foreclosure rate – 158%. Housing prices in Miami have dropped more than 17% -- versus an average of 8% nationwide.

It is falling home values that Bernanke says are causing the real turmoil. He says more homeowners are discovering it's not worth continuing to pay the mortgage when the house is now worth less on the market than the amount of the mortgage due.

The result? Too many people decide not to pay up and homes are going into foreclosure. So, Ben Bernanke is asking for a vigorous response -- encouraging lenders to reduce the principal of some problem loans.

The Fed Chief says that would reduce the risk of delinquencies and defaults. He adds that in the long term, this would do a lot to stabilize house prices and is in lenders' and investors' best economic interest.

Bernanke cited statistics, showing that in a typical foreclosure, the lender loses more than 50% of the mortgage balance due. It also costs the average company another 10% in expenses to take over and sell a property.

Bernanke says most loan modifications focused just on reducing interest rates may not be effective -- that borrowers with repayment plans re-default at high rates. The head of the

Fed also urged Congress to reform the Federal Housing Administration. Bernanke believes giving the agency more latitude to guarantee more refinancings and set underwriting standards could help reduce foreclosures. He said Fannie Mae and Freddie Mac could be more effective securitizing loans if they were allowed to raise more capital.

The proposal to reduce the principles of many mortgages -- a new idea from Bernanke Tuesday -- may be a tough sell for the lending community. Many argue if house prices continue to fall, lenders might be pressured to write down loans' principal amounts again. If housing prices turn up, they would not share in any of the gains. Chet?

Chet: “What does the White House think about Bernanke's suggestion to lenders that they write down more principles?”

Mont: “Well, the nation's Treasury Secretary said the Bush administration's strategy of encouraging lenders to reduce interest rates instead is the right approach and that the country is making substantial progress.

Henry Paulson says most other proposals would do more harm than good. He feels homeowners should be accountable for their actions -- that it's not the government's responsibility to bail them out if home prices drop below mortgage amounts.

NECN’s Mont Fennel has details.