This post on Matt Savinar’s Life After the Oil Crash forum makes an important observation about why the situation with residential (and now commercial) real estate loans is probably much, much worse than the powers that be would have us think. Banks are reluctant to foreclose because it forces them to go from counting the full amount of a loan as an asset to only counting the much lower amount they were able to get from the sale.
On the ongoing residential bust, I always wondered why banks weren’t simply willing to pull the trigger and get rid of the foreclosed homes for whatever they could get. Well, its not that simple, bc in the end, they don’t have enough capital to take the losses, so they have to hold them and claim a false value on the defaulted properties hoping they can sell them later at the price they have in the properties. This is banking Enron style.
Why must they show them on their books with false inflated values? Keep in mind the assets and liabilities of a bank. Deposits are liabilities that in addition they have to pay interest on. Loans are considered assets, as long as they are good. Basically, the assets and liabilities of a bank must maintain a certain proportion, otherwise, they are bankrupt. So, when a bank forecloses, they take the house back, replacing the asset value of the good loan with the asset value of the home they are holding – if they take a loss on the home or mark it down to its true deflated value, it reduces their assets.
The problem is, with this housing crisis and so many houses in default, the banks cannot possibly take the losses or mark the homes they hold down to their true value. If the banks told the truth and wrote the value of these assets down or sold them for less than owed, the banks would effectively bankrupt themselves. Thus, out of economic necessity, the banks do not mark the value of the houses down. Even though they show these homes as an asset on their books, they are really a liability because the bank has to maintain insurance on them and pay taxes. Ouch!
The bank regulators, the FDIC or the OCC can’t possibly do their job and "examine" the books, otherwise, most banks would go into receivorship. So, the regulators turn a blind eye to all but the most egregious.
This little charade leads to a very real practical problem which is this, they can’t keep making loans. They are effectively out of capital to lend (compounded even further by deposits going down bc of job losses etc). This is true in my area. The banks all here say, no worries, we’re doing fine. They all say they are still making home loans. But, actions speak louder than words. So, what are they doing? They aren’t making home loans. A bankruptcy trustee said a realtor had 21 contracts to buy with qualified buyers, but not a single one of them qualified for a loan. What does this mean? It means the banks are effectively all bankrupt, even though the FDIC hasn’t closed them yet. Its a charade. Don’t believe it. Get your money out.