An article on the front page of yesterday’s New York Times explained something that has been puzzling me. If a house is worth less than the value of a mortgage, and a bank forecloses on it, they lose the difference between the mortgage and the price they can sell the house for. Since the foreclosure process itself costs them something, it would seem to make sense for banks to offer to reduce the mortgage. Doing so would save them the foreclosure costs, and would keep more people in their homes. However, banks seem very reluctant to do this. They lobbied, successfully, against a law letting bankruptcy judges rewrite mortgage terms, and they have generally been unwilling to rewrite them themselves.
Here in Boston, City Life/Vida Urbana has been organizing anti-foreclosure, anti-eviction campaigns for both tenants and homeowners. (Banks don’t like to manage rental properties, so when they foreclose they often try to evict all the tenants and leave the house standing empty.) They rally activists from around the city to try to blockade scheduled evictions through civil disobedience. These evictions are frequently called off at the last moment because the bank has agreed to sell the house to the tenants, or to rewrite the mortgage — so why don’t they do that all the time?
The Times article is about “short sales” – selling a house for less than the amount of the mortgage – not “workouts” (agreeing to let the owner pay less than the true mortgage amount), but some of the factors apply to both.
Most basically, if a bank forecloses on a house it can keep that house on its books as an asset at the face value of the mortgage, while if they rewrite the mortgage, or accept a short sale, they have to write off the loss. Their real assets are the same either way, but if they don’t have to account for the loss they appear to be doing better than they are.
Second, they are afraid of moral hazard – if people think they can get the mortgage reduced, they will not do as much as they could to make the payments. And there is some possibility of fraud – people will just say they can’t pay, or will sell a house to a relative and then buy it back later.
So the banks aren’t just being stupid, they have reasons for what they do. Unfortunately, the above logic leads them in a direction that is not in the public interest. It certainly does not serve the people being evicted; and it does not really serve the banks, because it makes them unstable. No bank wants to be the first to write off all its mortgage losses, because that will hurt their competitive position; but at some point they will have to do it, and until they do no one can tell what the bank and its stock are actually worth.
This isn’t just my leftist point of view – the neoliberal Economist has just called for Congress to pass a law to let bankruptcy judges write down mortgages, or to give foreclosed-on homeowners a right to wrent their own homes, or even a federal subsidy to keep the creditors from losing if mortgages are reduced. If even they – normally free market advocates – are calling for this, then it’s time to do something.
This is what drives me crazy – if they just changed the law so that banks had to take the asset loss at the time of forclosure the following would not be true and it would not cost the government anything to implement.
“Most basically, if a bank forecloses on a house it can keep that house on its books as an asset at the face value of the mortgage, while if they rewrite the mortgage, or accept a short sale, they have to write off the loss. Their real assets are the same either way, but if they don’t have to account for the loss they appear to be doing better than they are.”