Banks: Why Approve A Short Sale When You Can Get A Bailout Instead

With the federal government appropriating close to a trillion dollars to spending and stimulus programs and the Federal Reserve private bank system pumping into the markets close to $10 trillion in cash reserves, can there really be a liquidity crisis anymore? And if so, how many more trillions of dollars of liquidity will be needed to solve the problem?

It should be obvious by now to anyone paying attention that the markets are not in need of more liquidity. Through the initial $300 billion Troubled Assets Relief Program (TARP), the US Treasury invested in banks and bought special types of preferred stock. In response, the banks receiving TARP money essentially hid it in the mattress.

The real problem is that the value of many of the assets that once backed up the debt securities held by these banks have fallen so dramatically. This was bound to happen when the banks started taking advantage of the Federal Reserve's artificially low interest rates to start giving loans to people who would never be able to pay them back.

Values were inflated by everyone involved in the real estate transaction and everyone went along with the bubble psychology. Borrowers wanted to get in on a bubble economy and were willing to finance 100% of the purchase price, knowing they could just sell in a year or two and make a large amount of money.

Real estate agencies knew that the value of the property and its sales price would determine their commission.

Mortgage brokers knew that their pay (through commissions, fees, yield spread interest) would be based on the loan amount.

Appraisers knew that if they failed to appraise a property for the maximum marginally-plausible amount, they would get no further business from lenders or mortgage brokers.

Banks knew that the larger the mortgage, the more the debt security would be worth. And they also knew that, if the owners fell behind on their loan they could just refinance or sell and take their profits. And even if they did not sell, the bank could foreclose and sell it later on and take the profits of the inflating bubble for themselves.

When defaults started to increase and values began to fall, the dodgy debts became 100% worthless. People who can not pay a mortgage on a property with an inflated value can sell. People who can not pay a mortgage on a property that is underwater are forced into foreclosure unless they can work with their lender.

Values have fallen in real estate, but sellers can not list their properties for sale when the mortgage is 125% of the fair market value of the home. If they want to try to sell to stop foreclosure at all, they need to sell for a high enough price to pay off the mortgage company. And no one is buying at those prices anymore.

They need a short sale to be approved by the bank in order to sell for a reasonable price. But the banks are notoriously difficult to work with negotiating for short sales. If they ever acknowledge receiving the offer at all, it is too often turned down.

Then, a few months later, the bank forecloses and lists the property on the market for even less than the original short sale offer. The homeowners were not permitted to sell for a higher price to prevent foreclosure than the banks sometimes list the properties for after they take them back!

Currently, the banks are shooting themselves, homeowners, and home buyers in the foot in not accepting that property values have fallen. But the banks also have very little incentive to acknowledge falling home prices.

First of all, if home values were accepted to be lower than they were in 2006, this would instantly discount the value of the mortgage securities. Many banks that invested heavily in CDOs, MBSs, ABSs, and the rest would have to face that they are already bankrupt.

Second, banks are doing perfectly fine in receiving money from the feds to continue operations without having to acknowledge any of the mistakes of the past. Congressional tongue-lashings have been the worst most banks have had to face, and their reward for such public spectacles is usually billions, if not tens or hundreds of billions, of dollars.

Third, the government has stepped in to make it easier for banks to hide their losses on mortgage securities by pressuring the accounting world to relax mark-to-market rules. This makes it easier for the banks to keep inflated values of these assets on the books while their borrowers have to deal with actual falling property prices in the real world.

So a bank is able to keep a mortgage on its books valued higher than any rational buyer would ever pay for a particular home. The homeowners are facing foreclosure and would just like to sell for the market value and put the entire experience in their past.

But the banks and the government have facilitated a business environment where it is a better deal for the banks to avoid recognizing falling home values and simply decline short sales. Homeowners are forced to try to sell for what they know to be impossible prices.

Thus, the government allows housing prices to be propped up and gives banks incentives not to work with borrowers to sell properties. As a result, delinquencies increase, the banks declare the problem to be bad borrowers and "liquidity," and come begging to the government. The government hands them more money and gives them more incentives to prop up housing prices.

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