According to a Wall Street Journal article the largest 4, Too-big-to-fail US banks, that is Citi, JP Morgan, Wells Fargo and Bank of America have between them $2.8 TRILLION in HELOC loans.
For those of you who don’t know, HELOC stands for Home Equity Loan. These are loans taken out on top of your mortgage, against the equity you have in your house. They are also called Second Lien Loans. During the bubble years these were the loans people took out to ‘release the value’ of their property. In other words, as the paper value of houses went up, people took out loans against the rising value of their houses and spent the money on… stuff.
There is a MASSIVE problem for the holders of these loans. In the event of a default, the money made on the foreclosure sale of the house goes first to pay off the bank which holds the mortgage. ONLY if the mortgage is fully paid off will any money left be used to pay back the bank which holds the second Lien HELOC.
But house prices everywhere have declined well below the value they had during those bubble years. Which means that when the mortgage is declared as defaulted and sold at foreclosure there will NOT BE ANY MONEY for the HELOC holders. NONE. Now the banks and the FED know this. Everyone knows this. BUT the banks are still holding these HELOC loans at face value. The banks are claiming and accounting for these loans as if they were worth what it says on them – the full amount. Despite knowing that there is absolutely no possibility of recovering any of the value at all.
This may sound like fraud – and it would be for you or me – but for the banks it is called ‘mark to model’. This was the measure lobbied for by the banks after the sub-prime began and agreed by the FED, Congress and the FASB (Federal Accounting Standards) . The banks no longer had to mark these assets to the market value they could get for them at the time. They were allowed to make a ‘model’ of what likely ‘impairment’ to the full value the assets might suffer according to the ‘model’ the banks got its ‘smartest men in the room’ to work out for them.
As you might imagine these very smart men worked out models which showed that the ‘impairment’ would be very small. Thus the banks have valued their HELOCs at near full value. And still do.
Now let’s look at what the future might hold.
If the ‘real’ value at re-sale were lets say a modest 10% below their model value that would mean a loss across the four banks of $280 Billion. 20% would be $560 Billion. But lets stick to just 10% – despite KNOWING that the real loss would be 90-100%. But lets stay in banking lala land.
Even a mere 10% loss of $280 Billion would reduce the four banks Capital Ratio to around 1%! That means a bank run and closure.
So what do you think? WIll we get mark to market or will the fraudulent valuation continue? If it does continue then the banks will continue to claim and publish accounts showing the HELOC are worth face value and the banks are well capitalized. And remember this ‘well capitalized’ state is the basis of the current rally in their stock prices.
BUT here is the rub – HELOC’s DO get marked to market if the property is foreclosed and sold for what the market will pay. This is the reason banks everywhere, in the UK as well as the US – are NOT foreclosing or if they have to are buying the properties themselves through specially set up bank funded proxies.
So the real question is, how long can the banks keep properties form being foreclosed and sold – thus concealing not only the loss on the mortgage but the ZERO on the HELOCs they hold? How long? For this insane plan we are being forced to follow – the save the financial class plan – they have to do it until the bubble re-inflates the prices back to where not only the price covers the mortgage but also the extra value to ensure that the HELOCS don’t lose even 10% of their full value. How does that sound to you?
Hi Golem,
Who needs fiction, when apparently the reality is far more surreal, right? Seriously, very well written again. Thanks.
As it seems, the stinking reality is getting stinkier consistently week by week. Now, that's more or less a fact. But how is it all going to play out? What scenarios are the most probable? I'd love to know what you think, and I'm sure I'm not the only one here. Just a suggestion. 🙂
Cheers!
DM
Thanks Golem for filling in a blank I had regarding why banks would hold onto assets thus artificially keeping house prices high in the UK due to less housing being available. I cannot see how this can work because surely the housing market is like a huge machine which requires affordable housing for first time buyers who in turn release the owners of those houses to move up the chain and purchase the bigger houses. The fact that confidence everywhere is at an all time low, jobs are becoming scarcer, wages are on hold and the cost of living is getting higher would mean that the machine would stall…..forever. Wishing that something is so isn't going to fix the problem.
thanks for doing this blog – I am an avid reader, though not always confident enough on economics to post
zardoz3006,
Thank you for posting a comment. You don't have to be an expert to have an opinion and express your thoughts. Not here anyway.
For me, comments left are like oxygen. I hate the idea that I am just ranting away to myself.
Any reply no matter how short is wonderful.
Thanks.
As for the housing market – it helps to remember that the banks aren't interested in putting people in homes. They are simply focussed on income by whatever means and especially focused on hiding debts. They cannot allow too many foreclosures and now that they 'won' so much housing stock they cannot allow too great a price drop. Either event kills their claimed solvency.
But bank panic will not originate here unless Spain falls over due to its own bad bank debts and unemployment of 17%!! Bank panic will come from the US as it did the last time. There it is an almighty mess.
EU Hedge Fund Regulation Legislation.
Golem XIV, I have read with fascination and trepidation your thoughts on the financial crisis.Maybe you could comment on the opposition by the UK and Ireland on this proposal – I include this url from today's Irish Times – http://www.irishtimes.com/newspaper/finance/2010/0317/1224266441335.html
This article's point about re-inflating the bubble connects and somewhat answers my question on previous post.
The question is "How Long?"
How long can the losses be concealed and will it be long enough for another bubble to rise the tide of insolvency?
Pilibi,
I have tried to offer some thoughts in "Bank Reform – the lion that had its balls removed" Let me know if this goes any way to meeting your own thoughts.
Here is some oxygen 😉