Will the banks bail out overextended homeowners?

[powayseller]

I thank sdrealtor for bringing this story to our attention. We’ve talked before about lender reaction to massive loan defafults, and I am interested in early stories of how they will deal with it.

[Bugs]

I think some of you are forgetting that these numbers being bandied about are actual dollars – the kind you use to buy food and groceries. We’re not talking about Monopoly money that gets redistributed at the end of the game. Real greenbacks, real moula, real coin of the realm. I don’t know how else to bring this out of the abstract.

Banks are in business to make money and when they lose money they eventually go out of business, either by BK or by seizure. The feds don’t insure banks without having stringent rules in place for liquidity and “safe and sound” lending practices because in the end these banks are underwritten by the U.S. taxpayer.

In other words, if a bank or an investor writes off one of these big losses that means that someone (lender, investor, government insurance fund) is losing those dollars out of their pockets for good. You can’t “account” your way out of something like that.

I’m fairly shocked that some of you think a bank can routinely write off 6-figure losses and survive. I don’t think some of you realize how thin their margins are. How many good loans does it take to make up for a single 6-figure loss?

As for investors, they’re in the same boat. They literally can’t afford to be writing off these large losses in principal because their margins aren’t that big either.

Try to remember that the typical residential losses that contributed to the last S&L bailout were in the $20,000 – $50,000 range. Now we’re talking about losses that can already be 300% of that with the potential for losses of up to 800%+ of that by the time this is all over.

No, fuzzy math accounting is NOT going to enable these lenders and investors to subsidize the foolish decisions made by these FBs. And wishing for inflation to correct the distortion is a loser, too, because that would essentially force EVERYONE to pay for the stupidity of the few. That’s a morally bankrupt idea from beginning to end.

[lendingbubblecontinues]

There’s no reason to worry about whether the banks will “bail out overextended homeowners…

C’mon guys…don’t you know?:

“It’s a great time to buy or sell a home.”– National Association of REALTORS, 11/06

😉

[Bugs]

The only way I can see any logic in this is if one or more of these situations applies:

The market is one of those low-dollar markets where homes are selling in the under $200k prices to begin with. At that point the loss wouldn’t be very many dollars.

The lender is a portfolio lender in a relatively small town and they’re too exposed in the community to allow foreclosure cycle to start. In essence, they think that if they don’t foreclose on the first one they might be able to avoid the chain reaction long enough for the pricing trends to recover.

The bank’s management has been listening to an economist who parrots the NAR party line and they actually think this is a short term blip rather than a long term decline.

No matter how you slice it, this is a risky move at best. It can only work for them if the soft landing occurs. And soon.

[PerryChase]

Bugs, your posts are excellent. I agree with pretty much everything you say. Sounds like you’ve had long time real estate experience in SD.

Yeah, the S&L collapse was caused by regional bubbles popping. I wonder what the coming national real estate downturn will bring us.

[hipmatt]

NO, the banks won’t. The bank would be bankrupt virtually immediately if they started doing this. They are in the business to make money, not to give away 100k to every tool that got sucked into buying a house at an insane price with an insane loan. This won’t happen.

[Mexico Resident]

I agree with Bugs completely. It never fails to amaze me that people can think a huge loss for a business is nothing. And I think it is worth repeating that even if this scenario were to take place, basically you are stating as a given that there is a real estate disaster. That won’t stop the collapse, it sounds more like the aftermath.

[La Jolla Renter]

According to a few CPAs I know, homeowners will not be hit with a tax bill on the debt forgiveness if it is on the 1st trust deed. 2nd’s are questionable.

[equalizer]

IRS quotes in this article

<http://www.sfgate.com/cgi-bin/article.cgi?file=/chronicle/archive/2005/06/05/BUGG5D3FNS1.DTL&gt;

non-recourse loans. You will have a capital loss of $60,000 ($540,000 in debt minus your cost basis of $600,000.) You won't owe tax, but you won't get a deduction if this is your primary residence. The biggest hit will be to your credit rating. In most instances, if you refinance your house, the new loan is a recourse loan, says Michael Pfeifer, a real estate attorney with Pfeifer & Reynolds. However, Roger Bernhardt, a professor at Golden Gate University School of Law, says there is no California case law that definitively establishes this as fact.

recourse loans Cancellation of debt is not taxed if the loan forgiveness was intended as a gift (not likely unless the lender was a close relative), if the borrower is bankrupt or insolvent and in certain other cases.

Pretend you bought a house for $100,000. Its value goes up to $280,000. You refinance your original mortgage with a new one for $250,000. The value goes down to $200,000, you default and the bank forecloses. This will probably be treated as a recourse loan because it was not acquired to buy the house. Assuming you still owe $250,000, you will have $50,000 in cancellation of debt income and a capital gain of $100,000 ($250,000 market value minus $100, 000 cost basis.) Once again, the capital gain won't be taxed because it falls within the exclusion for primary residences.

[zeropointzero]

Wouldn’t it just be simpler for the lender to let folks defer payments rather than give up principal? I mean, in terms of having to re-record the deed (or whatever is needed) and take an record an instant and signifigant loss on their books?

Maybe I’m not sophisticated in terms of understanding the banking/lending industry, but it just seems like this is the LAST thing a bank would want to do in terms of accounting priorities – and also, to a lesser degree – fairness and complexity issues.

[equalizer]

Zeropointzero is that your mortgage rate? 🙂

I agree that  banks would just defer or reduce payments for 6-12 months before taking any other drastic actions.  

[sdrealtor]

I guess you are missing the point. The cases where this HAS BEEN done are homes about to be foreclosed upon where there is a motivated individual that wants to but cant afford to stay in their home. There is a loss that is about to be recognized. The bank DOES NOT have the option of recognizing the loss or not. It is imminent. What they are doing is mitigating their loss and taking the writedown without going through the expensive foreclosure process. I’m sure it is done on a case by case basis and not something that would be widely advertised. Certainly not a single solution for the bubble but simply another tool that could be used.

[barnaby33]

Davelj, reversion to the mean, maybe a bit of overshoot is doom mongering? I think not. We always come back to that, just like, “who’s ox is being gored.”

Josh

[zeropointzero]

Well, thanks for illuminating this practice, SD. I see why a bank might do this in certain situations. I’ll certainly look forward to seeing if it becomes something that actually becomes something that we hear more about. I still think it’s odd that they can’t figure out a way to reduce payments or change the amortization schedule rather than write off principal. These bankers must think the road back for the RE market is going to be a long one.

The funny thing is that they’ll probably get some of the houses back in forclosure, anyways, even with the principal forgiveness

[powayseller]

THere is no way this will become widespread. Most mortgages are held by the GSEs and MBS investors. No way will Fannie Mae shareholders or MBS investors give away parts of homes. It would be cleaner for the bank to extend the payment terms, or to change the late payment into a balloon payment.

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