The Federal Reserve Board on Tuesday said it will require loan modifications on mortgage assets that were held by banks that defaulted on their discount window borrowings.
That is unlikely to help many homeowners, because banks rarely default on discount window loans.
"The goal of the policy is to avoid preventable foreclosures on residential mortgage assets that are held, owned, or controlled by a Federal Reserve Bank and that are subject to the policy through sustainable loan modifications and other actions that are consistent with the Federal Reserve's obligation to maximize the net present value of the assets for the benefit of taxpayers," Fed Chairman Ben Bernanke said in a letter Tuesday to congressional leaders, announcing the program.
Both Senate Banking Committee Chairman Chris Dodd and House Financial Services Committee Chairman Barney Frank praised the Fed's move.
"This is an important advance, and I hope to work with the board to strengthen the program," Sen. Dodd, D-Conn., said in a press release. "I also urge the board to work with consumer advocates to develop the most effective program possible."
Rep. Frank, D-Mass., said he welcomed the plan but that it was overdue.
"I'm very glad they are doing it," Rep. Frank told reporters. "I understand they are doing it under" the legislation, but "they could have done that all along."
"It vindicates our view that we gave them plenty of authority under the … bill," Rep. Frank said.
The central bank's program, required by the financial rescue law enacted in October, also aims to modify loans pledged as collateral under government aid packages provided to American International Group Inc. and Bear Stearns Cos. That should help more people, because the Fed already has control of that collateral.
The broader program applies only to loans that banks had pledged as collateral to borrow from the central bank. The Fed said it will review those assets that qualify for the program to determine which loans will provide more value with a modification than a foreclosure.
Loans qualifying for a modification must be at least 60 days delinquent. However, other loans in which the borrower is expecting payment difficulty may qualify as well. Modifications may include interest rate reductions, an extension of the payment term, and principal deferment or reduction.
Under the program, certain modified loans would have to have a debt-to-income ratio of 38% or less, a term no longer than 40 years, a fixed interest rate, and "a reasonable likelihood of being repaid by the borrower," the Fed said.
The Obama administration is expected soon to announce a much broader loan modification effort that builds on a program the Federal Deposit Insurance Corp. started after it seized control of from IndyMac Bank, a California thrift which failed in July. (The FDIC took over the thrift as a conservator, but is finalizing a deal to sell it to a consortium of private-equity investors.)
The FDIC and consumer advocates have called on the Treasury Department to implement a more universal loan modification program across the industry, which would provide servicers with a guarantee of up to 50% of losses from modified loans.