It’s time to start writing off principal amounts on mortgages. That’s the message Federal Reserve chairman Ben Bernanke has for the mortgage banking industry, as the U.S. economy faces increasing peril amid a worsening housing crisis. In remarks delivered Tuesday to the Independent Community Bankers of America Annual Convention in Orlando, Bernanke said lenders and investors need to be more willing to reduce the principal balance of many mortgages if foreclosures are ultimately to be avoided. “To date, permanent modifications that have occurred have typically involved a reduction in the interest rate, while reductions of principal balance have been quite rare,” he said. “But the current housing difficulties differ from those in the past, largely because of the pervasiveness of negative equity positions.” Bernanke said that borrowers increasingly have “less financial incentive to try to remain in the home,” making principal reductions a “relatively more effective” means of avoiding foreclosure. Borrowers simply walking away from their homes — and their mortgages — have become an increasingly concerning theme for market participants and policymakers alike. (See earlier coverage on this issue). “Lenders tell us that they are reluctant to write down principal,” Bernanke said. “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.” To counter that hesistance, Bernanke endorsed the idea of a “short refi,” where investors take a payoff of the original loan for less than the original balance and allow the borrower to refinance into a new loan at the current value of the property. “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 re-default,” he said. The Office of Thrift Supervision has recently been floating a plan that would create “negative equity certificates” for underwater borrowers, essentially turning any writedown of principal into an unsecured debt note that could in theory be traded and would also be tied to the borrower in the event of future price gains. “Although lenders and servicers have scaled up their efforts and adopted a wider variety of loss-mitigation techniques, more can, and should, be done,” Bernanke said.

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