Rather than cling to the illusion that they'll get repaid in full, banks should face up to their losses from all those bad mortgages they underwrote, Federal Reserve Chairman Ben Bernanke told bankers Tuesday.
It's time to take the losses onto the books, so they and the rest of the economy can move on, he said.
All the debt counseling, foreclosure freezing, HOPE alliancing, and interest-rate reducing haven't made a dent in the problem yet. So far, he said, you haven't done nothing.
Bernanke's remarks were the clearest sign yet that he's beginning to understand the full extent of the mess the banks made.
"This situation calls for a vigorous response," Bernanke said in a speech to the Independent Community Bankers of America. The only way to avoid millions of foreclosures is to figure out how to reduce the principal amount the homeowner owes.
In other words, face up to the fact that home prices have plunged and won't go back to lofty levels for a long, long time.
Because foreclosure is so expensive (taking 50% of the principal in legal fees, missed payments and other expenses), it probably makes more sense (and dollars) for the lender to simply write down the value of the mortgage to what the home is actually worth on the market. Writing down the principal would allow the borrower to refinance into an affordable mortgage in many cases.
That would keep many families in their home, and help housing prices adjust.
Bernanke's idea is simple in theory but terribly complex in practice. Because most of these mortgages have been securitized, writing down the principal could require the agreement of dozens, or hundreds, or even thousands of "owners."
But Bernanke was optimistic that the brilliant minds who cooked up the complicated financial instruments that got us into this problem can also figure a way to get us out.
And if they can't, maybe it's time for more "vigorous" action from someone who can.