Bank inflexibility may lead to government forced writedowns

Currently there is growing pressure to relieve homeowners by forcing the banks to reduce second mortgages on properties.

From the Wall Street Journal…

“Pressure is growing on U.S. banks to ease terms for distressed homeowners on home-equity loans and other second-lien mortgages. Rep. Barney Frank, chairman of the House Financial Services Committee, last week sent a letter to the four biggest U.S. banks demanding "immediate steps to write down second mortgages."

It appears that the banks enjoy the current lending environment but do not want to concede to rectify the burdens carried by underwater homeowners.

What I read in the bible this morning…

Proverbs 28:8

“ 8 He who increases his wealth by exorbitant interest
amasses it for another, who will be kind to the poor.”

The government may be the instrument that makes the banks recognize their losses and allows the house poor individual to shake free of their debts. But if that is done, the banks could face another major capital problem.

“Most first-lien home loans are held by the government-controlled mortgage companies Fannie Mae and Freddie Mac or by other investors in mortgage securities. By contrast, banks hold most of the seconds and other junior-lien mortgages. About $1.05 trillion of junior-lien home mortgages were outstanding as of Sept. 30, according to the Federal Reserve. Of those, $766.7 billion were held by commercial banks; most of the rest were owned by savings banks and credit unions.
If banks are forced to write down or write off large amounts of those second mortgages, many would suffer major dents in their capital. Laurie Goodman, a senior managing director at mortgage-bond trader Amherst Securities Group LP, said regulators may need to allow banks to recognize losses on second-lien loans over an extended period to avert a disastrous immediate hit to their capital.”

Even though the loss should be recognized immediately, the banks will continue to carry the loans above market prices until forced to do so. But something could go wrong with the bank's plan. This will be an interesting issue to watch over the next few months.