What's the real reason that banks aren't foreclosing?

Daniel Indiviglio writes for The Atlantic The “Shadow” Foreclosure Inventory

…Driving around Fort Lauderdale, it became extremely clear just how big a hit its economy has taken as a result of the real estate market’s collapse. It’s like a different world compared to what it was like just a few years ago: overgrown grass rises above many curbs and sidewalks; homes and businesses sit empty and abandoned; most blocks display multiple “for sale” or “for rent” signs.

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During my trip to Florida I heard about families who have lived in their homes as long as two years without paying, because the banks haven’t gotten around to foreclosing. And that’s a problem. Until the real estate market recognizes all its losses — including accounting for all foreclosures — it won’t be able to regain real stability and move on. Of course, that has implications for the broader economy as well.

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But what are the actual numbers as they pertain to this shadow inventory of foreclosures? They’re hard to get exact, given the very nature of the problem — these foreclosures have not yet been completed. But the (Wall Street) Journal does provide some statistics to work with:

As of July, mortgage companies hadn’t begun the foreclosure process on 1.2 million loans that were at least 90 days past due, according to estimates prepared for The Wall Street Journal by LPS Applied Analytics, which collects and analyzes mortgage data. An additional 1.5 million seriously delinquent loans were somewhere in the foreclosure process, though the lender hadn’t yet acquired the property. The figures don’t include home-equity loans and other second mortgages

Moreover, there were 217,000 loans in July where the borrower hadn’t made a payment in at least a year but the lender hadn’t begun the foreclosure process. In other words, 17% of home mortgages that are at least 12 months overdue aren’t in foreclosure, up from 8% a year earlier.

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So why do we have this shadow inventory? There are three possible causes:

The first is explained in the WSJ piece. It’s taking quite a long time to figure out which borrowers qualify for the Obama administration’s mortgage modification program. It’s also taking time to process the deluge of applications. During the wait, borrowers remain in their houses which, otherwise, would be in foreclosure. Those who don’t get the modification will ultimately face foreclosure.

Second, with so many foreclosures, banks likely just have logistical issues getting them all processed in a timely manner. There’s a heap of paperwork and other red tape involved in making a foreclosure happen. Banks have never experienced a flood of foreclosures like this, so they aren’t equipped to handle so many very quickly.

Third, banks may not want to foreclose on all of these homes immediately. A WSJ source above used the analogy of foreclosures hitting the market like “a fire hose or a garden hose or a drip.” Which do you think would be better for housing prices? The drip.

While it’s clear that the “shadow inventory of foreclosures is enormous, I don’t agree that any of these reasons are the real reason why banks aren’t foreclosing.

First, banks have had plenty of time to sort out who qualifies for a modification. In the couple of months after the modification plan was announced NODs and NTSs began to increase rapidly…indicating that the banks were able to sort through their customers quickly. However, in the last couple of months, NOD and NTS activity has fallen dramatically. See the chart below from ForeclosureRadar. There must be another reason why banks aren’t foreclosing.

Second, banks have been gearing up for the tidal wave of foreclosures for 2 years now. I work with asset management companies that hired and trained new employees in 2007 and 2008, only to let them go in 2009 because the business isn’t coming. And, none of the asset managers I work with at banks are very busy either. Being overworked isn’t the problem.

Third…I think this is where the reporter comes close, but misses the bigger picture. Banks don’t care about home prices. They care about not losing money. Because the government changed mark-to-market accounting rules, the link between low prices and losing money is broken.

Banks make more money by NOT foreclosing on homes. Banks are dragging out the foreclosure process for their own selfish reasons. Until the day they foreclose, the amount of money owed to them is an asset…sure, it’s an asset that isn’t paying interest payments…but it is still an asset. The day they foreclose, a $400,000 asset could become a $150,000 asset and a $250,000 loss.

Multiply that loss by 10, 20, or even 30 times leverage and there are several million dollars worth of new loans that the bank can’t make.

Faulty government programs and doctored accounting rules have produced the fiasco before us: There are roughly 4 million homes that should be foreclosed on but they won’t be any time soon. This enormous can is continuing to get kicked down the road.

Economists are predicting a recovery. They say that our various programs are making an impact. In reality, all they’ve done is kick our can of reckoning a little further down the road.