Tuesday, September 7, 2010

EXTEND AND PRETEND

One national real estate figure calls it "extend and pretend."  Others refer to it as "kicking the can down the road."  I sometimes simply think the banks are holding onto their worthless chips because at some point, the government will redeem them once again.

What we are all referring to is the increasingly common tendency for banks to stop short of foreclosing on homeowners who have fallen delinquent on their loans.  Let's face it - the banks (at least the big ones, who survived) did very well with their 2008 and 2009 government bailouts, moving worthless loans off of their balance sheets and on to the ledger of the federal government.  Many smaller banks were swept away, but for the likes of Chase, Citi, B of A and Wells Fargo, being a survivor is profitable.

With the government agreeing to take so much bad debt (at taxpayer expense), it was important to keep things looking as manageable as possible.  Pulling this off required one simple ruse - getting everyone to believe that those losses ultimately wouldn't be very big.

To do this, the government changed the rules. The FDIC, which previously forced banks to get bad assets off their books, became a leading proponent of saving homeowners with loan modifications that likely just delay the inevitable.

With a little government pressure, the supposedly independent Federal Accounting Standards Board allowed banks to account for loans at theoretical values that were based on computer models rather than current market value.

An acronym soup of programs followed, which were promoted as providing help for America's homeowners: HAMP, HAFA, HARP, 2MP and more. But the reality is that, to date, these programs have resulted in little more than delays.

But delays can be profitable, if they allow banks to extract at least some payments (or partial payments) from homeowners who are ultimately not going to keep their homes.  By keeping the bad loans alive, the banks have a leveraging chip for future government aid while looking more compassionate in the interim.

The problem facing both lenders and the government is that they can neither kick homeowners out or bail them out, because either scenario forces the losses onto the books, which affects earnings, reserve requirements and investor relations.  The easier model is to delay confronting the problem, which works so well for the federal government that the banks are eager to give it a try.

Because I track foreclosure activity very closely (including pulling NED lists on a weekly basis in several of the neighborhoods where I work), I've seen this increasing reluctance to pull the trigger on homeowners who are clearly in default. 

I'm also seeing homeowners in foreclosure become increasingly adept at gaming the system, even renting out their homes on their way out of the neighborhood to create positive cashflow while they fail to make payments month after month.  This is one byproduct of a "soft enforcement" policy on defaulters.

To combat the spread of this mentality, lenders have to foreclose on a certain percentage of homeowners each month, or else the system will simply break down.  Call it foreclosure roulette.  Maybe it's your time to go... but maybe they'll give you six more months.

Trillions of dollars in negative equity is a serious problem, and I'm not advocating the "crash landing" approach to letting the markets reset.  But more creativity is called for here, whether it's creating a federal property management agency (renting back to foreclosed homeowners) or writing tougher legislation to limit the growing number of "strategic" defaults from owners who just decide to walk away. 

Letting the big banks set the rules, knowing the federal government views them as "too big to fail", is grossly unfair.  Taxpayers (and voters) deserve better.