U.S. to take on credit crisis

Times Staff Writer

Hoping to calm turbulence in the financial markets, President Bush and Federal Reserve Chairman Ben S. Bernanke took separate steps Friday to ease the credit crunch that has socked investors and dried up access to home loans for millions of Americans.

In their remarks the two leaders displayed a painful recognition that the credit crisis -- triggered by a wave of defaults on sub-prime mortgages -- had ballooned beyond anything they had anticipated.

Speaking in the White House Rose Garden, Bush promised new help for people who are behind on their mortgage payments and in danger of losing their homes. But he insisted that the government didn’t intend “to bail out speculators or those who made the decision to buy a home they knew they could never afford.”

The most immediate effect of the president’s plan will be to help as many as 80,000 troubled borrowers refinance their homes with government guarantees. As many as 2 million homeowners with adjustable-rate mortgages could struggle to make payments as their loans reset in the next few years.


Shortly before the president outlined his proposals, Bernanke said the central bank would do whatever would be necessary to ease the credit problems’ effects on the economy and the 6-year-old expansion.

Bernanke’s speech at a Fed conference in Jackson Hole, Wyo., was taken as further evidence that the central bank intended to cut interest rates unless credit conditions improved. The stock market reacted by rallying, with the Dow Jones industrial average jumping 119.01 points, or 0.9%, to 13,357.74. Other key indexes gained more than 1%.

The credit crunch was set in motion after mortgages issued to people with poor credit began to see high default rates late last year. That spooked investors who helped fund such mortgages.

As investment funds reported huge losses on mortgage-backed securities, an aversion to risk-taking took hold. Many companies found it more difficult or costly to borrow, and stock prices tumbled from record highs set in July. Now many prospective homeowners, even those with good credit, are having trouble getting mortgages.


In their appearances Friday, Bush and Bernanke -- the two figures with the greatest influence on the U.S. economy -- seemed to concede economic realities contrary to their primary philosophies.

For the president, this included a rare critique of free markets and an acknowledgment that there might be a role for government in solving the problem.

“Unfortunately, there’s . . . been some excesses in the lending industry,” Bush said “This has led some homeowners to take out loans larger than they could afford, based on overly optimistic assumptions about the future performance of the housing market.”

Others, he added, may have been “misled by irresponsible lenders.”


“There are many American homeowners who could get through this difficult time with a little flexibility from their lenders or a little help from their government,” Bush said.

Bernanke, meanwhile, offered a grudging admission that maintaining financial market stability was crucial to encouraging sustainable growth and therefore one of the Fed’s duties.

The central bank chairman had signaled his intention to break with his predecessor, Alan Greenspan, by untangling the two and focusing almost entirely on the economy. Some critics have said Greenspan was too willing to cut interest rates to rescue the markets during periods of turbulence, and they blame him, at least in part, for the technology and housing bubbles of the last decade.

Bernanke seemed genuinely chastened by the dimensions of the crisis.


“Although this episode appears to have been triggered by heightened concerns about sub-prime mortgages,” he told his Jackson Hole listeners, “global financial losses have far exceeded even the most pessimistic projections of credit losses from those loans.”

Bernanke appeared to go out of his way to say that markets and the broader economy were inexorably entwined. “Developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.”

He said the central bank “stands ready to take additional steps” to counter the freeze-up and “will act as needed to limit the adverse effects on the broader economy that may arise from the disruptions in financial markets.”

Although the president recognized free-market failures and the Fed chairman acknowledged financial market spillovers, neither man has moved very far from his basic views, suggesting that both believe the markets and the economy will ride out the current storm this fall, even if at some cost to growth.


Bush’s proposal would allow an estimated 80,000 additional borrowers to refinance in the next year or so by obtaining new mortgages insured by the Federal Housing Administration, a New Deal-era agency that insures low- and middle-income borrowers.

To qualify, applicants must prove that they have been making their payments and landed in trouble only when the so-called teaser rates that enticed them into their mortgages expired and the loan reset at a higher rate. The payment increase must occur between June 2005 and December 2009. The borrower must have at least 3% equity in the house and a history of sustained employment. The program also wouldn’t apply to mortgages larger than $362,000, ruling out many homeowners in California and other high-cost states.

Borrowers in the program would be likely to get new 30-year, fixed-rate loans. The interest rate on FHA-insured loans being issued now is about 6.5%, and the owners will have to pay an annual insurance premium of as much as 2.2% of the amount of debt outstanding.

Officials with the Department of Housing and Urban Development estimate that of the 2 million mortgage holders thought to be behind on their payments or at risk of falling behind, half a million are likely to default. They are the prime target for the new program. Based on the latter figure, the program will aid fewer than 1 in 6 of those it is intended to help, a rate that drew criticism from experts.


“It’s not enough,” Peter Morici, a University of Maryland economist, said. “We have a lot of people whose mortgages are greater than the value of their houses, and this program won’t do anything for them.

“It’s a Band-Aid, and not a very big one at that,” Morici said.

In addition to the mortgage insurance, Bush said he would seek to temporarily change a provision of the tax code that penalizes some homeowners who refinance their mortgages to reduce their payments or who lose their houses to foreclosure. In an example cited by the president, if a house loses $20,000 of its value and the homeowner persuades his or her bank to forgive $20,000 of the mortgage, the government currently will treat that amount as taxable income.

“When your house is losing value and your family is under financial strain, the last thing you need to do is to be hit with higher taxes,” Bush said.


Although Bernanke increasingly accepts the link between markets and the broader economy, he and his fellow Fed policymakers have been very reluctant to do what market players most want them to do: reduce their benchmark federal funds rate, the interest rate at which banks make short-term loans to one another. The federal funds rate, which influences interest rates throughout the economy, remains at 5.25%, where it has been for more than a year.

As late as Aug. 7, Fed policymakers said that although they recognized that “credit conditions have become tighter for some households and businesses,” their chief worry remained inflation, not the possibility that the credit squeeze could stall growth. About two weeks ago, Fed officials changed their tune, saying that with the credit crunch and financial market turbulence, “the downside risks to growth have increased appreciably.”

The Fed cut the discount rate, the rate it charges banks that borrow from it directly, to 5.75% from 6.25%, and encouraged banks to engage in such borrowing, which they traditionally do not do.