Bernanke disappoints with this loser idea

in today's WSJ:

We've seen some puzzlers over the years, but we'll admit we never expected to see a Federal Reserve Chairman talking down the capital cushion of the nation's banking system.

But there it was on Tuesday, the equivalent of a CEO shorting his own stock, as Ben Bernanke encouraged the nation's bankers to write down the principal on millions of mortgage loans. Voluntary loan modifications aren't doing enough to stop foreclosures, declared the chief steward of the U.S. financial system. "In this environment," he said, "principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure."

Mull over that one for a moment. Mr. Bernanke and the Fed are charged with protecting the soundness of the banking system. The bulwark of such protection is shareholder equity -- capital -- which is generated in part by income-producing assets known as loans. Yet the Fed chief has now advised that, as a matter of public policy, banks should take a chunk of that capital and transfer it to mortgage debtors. How this additional charge -- and new political risk -- against bank earnings will ease the mistrust at the heart of the current credit crisis is a mystery.

This came only a few days after Mr. Bernanke had publicly advised Congress that more banks will fail. And it came on the same day that the Fed's Vice Chairman, Donald Kohn, told Capitol Hill that bank earnings are under increasing pressure. Amid such earnings strain and uncertainty about how far real-estate prices will fall, now seems an especially bad time for a Fed chief to instruct banks to create further losses.

Only the day before Mr. Bernanke dropped his bomb, Treasury Secretary Hank Paulson disclosed that "since July more than one million struggling homeowners received a workout -- either a loan modification or a repayment plan that helped them avoid foreclosure." In January alone, there were 167,000 such modifications, with the number of borrowers receiving help rising faster than the number of foreclosures.

Mr. Bernanke's broadside might well hamper these voluntary workouts by signaling to other borrowers that they needn't do anything at all.

Mr. Paulson had to wonder why Mr. Bernanke was undermining the Treasury Secretary's sensible public opposition, expressed on Monday, to a taxpayer rescue. Do the gentlemen not like each other?

The worst irony here is that the mortgage crisis is in large part the fault of the Fed's own reckless monetary policy. Low real interest rates for too long created a subsidy for debt that spurred the housing and credit bubbles that have now burst. Prices got higher than they should have been, and the first step in any recovery is letting those now-falling prices find a new bottom. Government interference in that price discovery will only prolong the crisis, increasing the chances that the losses are eventually dumped onto taxpayers.

Maybe I was wrong about the Bearded One.