Are Banks Playing Kick the Can with Mortgage Losses?

Posted by Jim DeBellis on June 21st, 2011

Most of us have assumed that the slowdown in the rate at which banks are processing foreclosures is a result of last fall’s “robo-signing” scandal. The banks must just be taking more care in getting it right now. Or did that temporary stoppage simply serve to give our financial wizards an excuse to keep things moving slowly with the intention of keeping huge losses from hitting their books?

Some of the more industrious writers are looking at this angle lately. Perhaps the signing scandal that shoved thousands of foreclosures into the pipeline was a blessing in disguise for the banks, and perhaps for the housing market too. Consider this: banks hold about $3 trillion dollars in mortgages that they paid out of their own cold, hard cash. We’ve been led to believe that just a few small percentage points of that amount are in default. But The Financial Times recently wrote, based on previously unpublished numbers from the Office of the Controller of the Currency, that 20% of mortgages held by the banks are more than 30 days past due.

That $600 billion dollars – and probably more, as it is more likely to be newer mortgages with higher balances that become delinquent – is well-beyond the amount that the banks’ loss provisions are able to bear, especially when you consider that they are recouping little more than 35 percent of the face value of these loans.

Of course, the slowdown in filing and processing foreclosures not only keeps big defaults from showing up on the ledgers of financial institutions, it also keeps home prices from crumbling even further. This would not only accelerate but also increase the already-unmanageable amount banks are losing on failed mortgages and make the housing market appear to be even further from recovery. But we all know that kicking the can down the road usually serves only to make things worse when the inevitable day of reckoning arrives.

The banks could probably hang onto about 70 percent of the face value of shaky mortgages if they would do more loan modifications, keeping people in the homes and paying rather than maintaining a slew of vacant houses. Foreclosures are expensive, as the bank has to maintain the properties, pay property taxes for months or years of vacancy, sell at severely distressed prices, pay commissions to Realtors, and pay for all of the foreclosure processing and court fees. It might be better to own-up to some of the looming losses now rather than lose it all later.