Federal Reserve Chairman Ben Bernanke came down firmly on the side of government action on Tuesday, urging banks to forgive part of the principal on loans they’ve made to borrowers who are now under water on their mortgages, and calling for a bigger government role in backing mortgages.

The New York Times goes above the fold on page one with a story that says the Fed and President Bush, despite his rhetoric, are moving toward a “government rescue” of borrowers and the home industry.

The Financial Times leads its front page with the news, saying:

…shows how policy-makers are considering increasingly drastic measures to tackle the troubles in the housing industry, where Mr Bernanke said “delinquencies and foreclosures will continue to rise for a while longer”.

“This situation calls for a vigorous response,” he said. “Measures to reduce preventable foreclosures could help not only stressed borrowers but also their communities and, indeed, the broader economy.”

The Wall Street Journal on A3 says Bernanke’s move shows the shortfalls of the current rescue plans, which have focused on freezing interest rates to help borrowers keep their homes. But with prices falling sharply, more than 10 percent of homeowners have negative equity on their homes—they owe more than they’re worth—and thus have more incentive to mail the keys back to their mortgage lenders. The WSJ quotes a study that says one in five borrowers could soon owe more than their houses are worth.

The Fed chief called for expanding the government’s role in guaranteeing big mortgages and those that are in trouble, something the NYT says the administration has already done. Even the liberal Barney Frank praised Bernanke’s newfound activism, the papers say. The banking industry frowned on it, though.

Bloomberg says Bernanke’s speech shows he thinks the problems can’t be addressed with fiscal and monetary policy—economic-stimulus plans and interest-rate cuts. It says Treasury Secretary Paulson contradicted Bernanke’s emphasis on helping under-water home borrowers, saying “almost too much” has been made of the issue. It will be interesting to watch how these splits between the Fed and the Bush administration widen or narrow over the coming months. Either way it will be a big story.

The NYT says the moves, of course, would leave taxpayers on the hook to effectively bail out homeowners and the housing and banking industries.

Banker pay under fire

The FT reports on its front page that the investment-banking industry is proposing new pay guidelines for itself in a bid to head off political pressure to reform how compensation gave bankers the incentive to take huge risks that held out the possibility of big payoffs for themselves with little downside for their pay.

The Institute of International Finance is considering proposals to defer bonuses until the long-term impact of bankers’ moves are clear, or to force bankers who lose money in their individual business units to make up the shortfall before they get any more bonuses. You know, like almost everyone else has to do.

The issue of banking pay is becoming particularly controversial because salaries in the financial industry have exploded this decade relative to other sectors of the economy. However, some sectors with the biggest pay-outs in recent years—such as complex credit—are in the storm of the current credit turmoil. Meanwhile, the banks are still paying high bonuses to many employees, in spite of a swath of writedowns.

This is triggering growing criticism of compensation structures among policymakers and some investors. “At present, compensation incentives are asymmetric…This encourages employees to take excessive risks,” says Philipp Hildebrand, vice-chairman of the Swiss National Bank.

The pay issue is an essential one that will be increasingly important and visible as the credit crisis unwinds over the next months and years. The incentive structures are gamed for short-term gains to the long-term detriment of their companies and to the economy.

Wamu to Street: Drop dead

Incredibly, the board of Washington Mutual is going the opposite way on the pay issue, the WSJ says on A3. It will exclude many of the effects of the credit crisis from its bonus calculations, something the paper says “effectively shields the pay of chairman and chief executive of the thrift, Kerry Killinger, and more than 100 other executives from the continuing mortgage fallout.” This from a bank that has been one of the hardest hit by the credit and housing busts, with shares down more than 70 percent from early last year.

Unsurprisingly, WaMu investors are ticked:

“They’ve cost their shareholders a lot of money,” said David Dreman, chairman of Dreman Value Management LLC, which holds 27.9 million WaMu shares. “Bonuses should be given to the executives who enhance shareholder value, not destroy it.”

Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.