The Federal Reserve announced this week that it will use its authority in the $700 billion Troubled Asset Relief Program to begin modifying mortgage loans for struggling homeowners in an effort to slow down the residential home foreclosure rate, Bloomberg reports (“Fed Adopts Policy to Modify Mortgages, Stem Home Foreclosures,” Jan. 27, 2009).

The Fed’s initiative, titled the “Homeownership Preservation Policy,” will specifically target $74 billion in mortgage assets the Fed acquired as part of last year’s bailout of Bear Stearns and American International Group and will allow the Fed to extend mortgage loan modifications to homeowners who are 60 days or more behind on their mortgage payments.

This is the first step the central bank has taken under the TARP law to help prevent foreclosures and to “promptly” review mortgages that would qualify for modification. Already, 850,000 homes have been foreclosed on and another 1 million homes are expected to be at risk of foreclosure in 2009.

“This is a very big deal,” said Barney Frank, chairman of the House Financial Services Committee. “It reflects the understandable desire of the Federal Reserve to have some cooperation.”

Principal Write-Downs Key to Program’s Success

The Fed says it will notify all homeowners whose mortgages it holds in assets if they’re eligible for a mortgage loan modification under the new policy, but the Fed has yet to announce just how many homeowners could stand to benefit. Eligible homeowners could see their interest rates lowered, their loan terms extended, or their principal loan balances reduced if the loan adjustments would offer them “a better long-term payoff than foreclosure,” suggests The Washington Post (“Fed Adopts Program to Stem Foreclosures, Jan. 28, 2009).

Unlike other third-party lenders who offer mortgage loan modifications, the Fed will specifically push for principal balance reductions under its own modification program, especially for those homeowners who owe more than 125 percent of their property value. Private lenders who have been doing home loan modifications have been reluctant to reduce principal balances on mortgage loans because of the potential revenue loss for the lenders.

Alan White, an assistant professor at Valparaiso University of Law, said these “principal write-downs are still the critical issue” to stemming the tide of home foreclosures. The Fed’s new strategy, if successful, could soon serve as a model for other mortgage holders.

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