Wednesday, January 6, 2010

Housing and Banking

One of the most disturbing statistics around these days is the status of home owners. The New York Times reported yesterday that it is estimated that one-third of homeowners with a mortgage, or 16 million people, owe more than their homes are worth. Any further drop in home prices, of course, would just enlarge that figure and exacerbate the problem.

This, to me, raises additional concern about the banking industry. My guess is that banks, and other financial institutions, haven’t taken this potential write down onto their balance sheets. For one, they don’t know which individuals in the 16 million are going to default on their mortgage and they don’t know when that is going to happen.

This is, of course, a very important reason for banks not to lend at this time. They are uncertain as to the real condition of their own balance sheets.

The forecast is for a new flood of foreclosed homes to hit the market later this winter and spring.
It has been argued that the best way to assist troubled borrowers is not through reducing the interest rate that has to be paid on the mortgage but by reducing the balance of the mortgage. But, this would mean that in reducing the balance on the mortgages of troubled borrowers, the banks would have to take the loss immediately, something they may not have reserved for, given the fact that they don’t know exactly who is going to need assistance. Many of the plans require the borrower to come in for assistance.

This, however, would reduce the capital that the bank has and threaten the existence of the bank.

And, how many banks are already on the problem bank list of the FDIC? At the end of the third quarter of 2009 the number was 552.

What might be the strategy of the banks?

Well, if banks amend the mortgage agreement to include a lower interest rate they do not have to recognize any loss on the loan at the present time.

But, analysts have said, this just postpones the problem and, in all likelihood, the borrowers will still not be able to pay back their mortgage and so this just slows down the recognition of the failure of the loan.

Right! That is the point!

Banks gain something by adjusting loan rates. They lose by granting principal reductions. By adjusting loan rates, they don’t have to take a charge-off right now. If they grant principal reductions they do have to take the charge-off right now.

Bankers are always more willing to postpone taking charge-offs in the hopes of the environment improving. At least that was my experience in doing bank turnarounds.

Furthermore, the location of the problem we are discussing is in the small- and medium-sized banks in this country.

The big banks, they are running away with huge profits gained from the excessively low interest rates (thank you Fed!) and the large trading profits made in bond and foreign exchange markets. This is not their problem, now.

Also, these small- and medium-sized banks face additional problems down the road in commercial real estate, car loans, and other extensions of credit made during the credit inflation of the 2000s.

It seems to me that Main Street is still not “out-of-the-woods” and that 2010 may be the time when the Main Street “shake-out” really occurs. I hope not, but we need to be aware of this possibility.

The total of 552 troubled banks is really disconcerting. It only seems to me that this number will rise in 2010 before it begins to fall. Best guess is, however, that there will be a lot of bank failures this year.


I would like to recommend the article in the New York Times this morning by David Leonhardt with the title “If Fed Missed This Bubble, Will It See a New One?” (

I would also suggest reading this article along with reading my post from Monday, January 4, “The Bernanke Fed in 2010.” (

Leonhardt quotes the recent Bernanke speech with regards to “lax regulation”: “The solution, he (Bernanke) said, was ‘better and smarter’ regulation. He never acknowledge that the Fed simply missed the bubble.”

Going further Mr. Leonhardt argues that “This lack of self-criticism is feeding Congressional hostility toward the Fed.” It is also fueling the criticism of other interested parties.

“He (Bernanke) and his colleagues fell victim to the same weakness that bedeviled the engineers of the Challenger space shuttle, the planners of the Vietnam and Iraq Wars, and the airline pilots who have made tragic cockpit errors. They didn’t adequately question their own assumptions.
It’s an entirely human mistake.”

From which Leonhardt concludes: “Which is why it is likely to happen again.”

Need I say more?

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