In a speech today to the Independent Community Bankers of America, Federal Reserve Board Chair Ben Bernanke urged banks to consider writing down the principal on troubled home mortgages voluntarily as a way to stave off borrower default and foreclosure. "In this environment, principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure." In workout jargon, a reduction in the principal balance of an obligation to increase the expected payout is known as a "haircut."
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Bernanke thinks the path out of the housing crisis requires government action. In particular, government-sponsored mortgage finance enterprises, Fannie Mae and Freddie Mac, could do more to address problems in housing and mortgage markets. "New capital-raising by the (government-sponsored enterprises), together with congressional action to strengthen supervision of these companies, would allow Fannie and Freddie to expand significantly the number of new mortgages that they scrutinize," he said. "With few alternative mortgage channels today, such action would be highly beneficial to the economy." Bernanke didn't mention amending the Bankruptcy Code to permit homeowners unilaterally to strip down mortgages. For bankers, a government imposed haircut feels more like a scalping.