WASHINGTON - The Federal Reserve, in a move that could point the way toward breaking the logjam at the center of the credit crisis, has adopted a new strategy to permit some troubled borrowers to reduce the amount they owe and refinance into more manageable mortgages - an approach that is likely to set the stage for a broader Obama administration attack on the foreclosure crisis.
The new policy, adopted by Fed governors without fanfare last week and provided to key lawmakers Tuesday, came as the central bank said yesterday that it would continue to hold its benchmark interest rate of zero to a quarter-point and pursue innovative ways to repair credit markets.
"Credit conditions for households and firms remain extremely tight," the Fed's interest rate-setting committee said in a statement. "The committee anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant."
The Fed is the first major mortgage-holder to explicitly endorse principal write-downs. Other government-endorsed loan modifications permit lower interest rates and longer terms, but do not include principal write-downs.
"There's been an increase in loan modifications, but none of them have involved principal reductions," said Guy Cecala, editor of Inside Mortgage Finance, a trade publication.
Officially, the new policy applies only to mortgages the Fed controls through three stand-alone companies formed to hold mortgage-related assets it acquired last year from the collapse of investment house Bear Stearns and insurer AIG. Those three companies hold about $74 billion in assets.
That is only a fraction of the total troubled mortgages and mortgage-backed securities, but the Fed has been in talks with the Obama administration about a broader program to accelerate the housing correction by spurring refinancings.
Also yesterday, bond investors had expected the Fed to announce plans to buy Treasury bonds in the open market as a way of keeping interest rates low. But the Fed said only that it's "prepared" to take such a move.