We noted yesterday Why Loan Mods Fail: Buyers paid much more than homes were intrinsically worth; Banks also lent more than they should have against over valued property.
Thanks to the replacement of Mark-to-Market with Congressionally mandated Mark-to-Make-Believe, these same banks have no incentive to reduce the mortgages. Banks get to carry property — even if its junk — on its books at full boat. Under those circumstances, Banks have little incentive to reduce mortgages.
Hence, without mortgage mod programs address the true underlying issue, we would expect these superficial mods to be destined to fail in large numbers. This is precisely what is happening.
As Twain once said, “He is an idiot and a Congressman, but I repeat myself.”
In the Sunday NYT, Gretchen Morgenson looks at a related issue — namely, what happens to 2nd mortgages and liens on these over valued, over encumbered properties.
Just four banks have $442 billion dollars in second mortgages and home equity lines of credit: Bank of America, Wells Fargo, JPMorgan Chase and Citigroup. As Morgenson notes, they have “zero interest in writing down second liens they hold because it would mean further damage to their balance sheets.”
Its yet another reason why mods are failing and the real estate sector remains mired:
“Say a troubled borrower has a first mortgage owned by a pension fund in a securitization trust and a second lien held by the bank that services the loans. The servicer is happy to modify the first mortgage under the Treasury program because the pension fund holding that loan takes the biggest hit while the second lien is untouched. This hurts the investor who holds the first mortgage and the borrower, who must pay off the second lien, which typically has a significantly higher interest rate.
The result? Yet another conflict of interest enriching financial companies while impoverishing investors and consumers.
An interesting data point: when banks do own all the mortgages on a property they seem to see the merit in principal reduction modifications. Studying second-quarter government data, the most recent available, Ms. Goodman found that when banks owned the loans, 30.5 percent of modifications reduced principal balances.
When they service someone else’s loan or hold a second lien on the property, they rarely allow principal reductions.”
This is why the Japanese model of saving banks, versus the Swedish model of saving Banking, was such a poor choice.
Banks are currently operating in a survival mode: They are hording capital, not lending, making decisions based on their needs. It is what they are supposed to do, and anyone surprised by this does not understand how coprorate entities make decisions or operate.
It is the reason why throwing billions of dollars are banks in the first place was the wrong decision: We should have followed the Swedish model. The FDIC should have put insolvent banks into receivership; they senior management is replaced, the shareholders wiped out, the debt written down to zero. The assets — the bad paper, the accounts, the healthy parts of the bank — gets sold off or spun out as a new public entity. It is adequately capitalized, without crushing toxic assets and piles of leveraged debt.
What we would have gotten for out trillions of taxpayer dollars was a well capitalized, low leveraged, low debt financial sector, capable of making loans and driving the economy forward.
Instead, we have a grievously wounded banking sector, clinging to its cash, fighting to survive, economy be damned.
How long will we be locked into this ineffective paradigm? This is the ill conceived plan of Hank Paulson, Ben Bernanke and George W. Bush during the panic months of late 2008/09. That ill thought out approach was bad enough; making matters worse is the fact that the same failing approach has been embraced by Tim Geithner, Larry Summers and Barack Obama.
The sooner we admit that TARP was a disaster and that the financial sector remains a debacle, the sooner we can get rid of the horrific Japanese model.
The Swedes brighter banking system beckon . . .
Why Treasury Needs a Plan B for Mortgages
NYT, December 5, 2009