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Signs of a Reckoning for Mortgage Debt

When it comes to bad mortgage debt, it appears that a reckoning is finally afoot.



) -- When it comes to bad mortgage debt, it appears that a reckoning is finally afoot.

Banks and homeowners have surely been suffering since late 2007, when the residential real-estate bubble first started to burst. But the full effect has also been blunted by various measures -- from eased accounting standards, to a foreclosure moratorium, and costly federal initiatives to repair the housing market, which put the burden on taxpayers.

Now, though, it's becoming increasingly difficult for banks to avoid taking the rest of the housing hit.

First, the mortgage purchasing giants

Fannie Mae



Freddie Mac


are combing through details of their mammoth portfolios of housing debt, forcing banks to take back bad loans that had underwriting flaws. This will not only cause banks to be more careful about underwriting practices, but to take on more souring loans.

The Federal Home Loan Bank of Seattle has also launched an attack of sorts, suing Wall Street banks in an effort to recoup more than $2 billion it paid for mortgage debt that has gone bust. The FHLB says an assortment of banks, including

Bank of America

(BAC) - Get Free Report

, its



JPMorgan Chase's

(JPM) - Get Free Report

Bear Stearns,

Goldman Sachs

(GS) - Get Free Report


Morgan Stanley

(MS) - Get Free Report

, underwrote mortgage securities poorly and misrepresented the quality of the loans.

Finally, the Federal Reserve is about to wrap up its $1.5 trillion mortgage-buying spree. The program was meant to ease strains in the credit markets. While the situation is nowhere near as dire as it was at the height of the crisis, the Fed's backing out will certainly make the debt waters choppier. Once the Fed is gone, the health of the mortgage-securitization market will once again be reliant on the health of private purchasers.

Amid all of the government push-back, banks are also tackling continued strains in the housing market itself. The mortgage workout plan has been

less than successful

, while the foreclosure moratorium has largely ended. By mid-year, banks will also have had to put a huge swath of

off-balance sheet mortgage debt

onto their books.

As a result, short sales are becoming increasingly popular. In a short sale, an underwater borrower can no longer afford mortgage payments and the lender decides that selling the property at a loss is more efficient than dealing with the headache and costs of modifying the mortgage. Both sides getting hurt -- the bank doesn't make whole on its loan, and the borrower takes a hit to his credit standing, and loses his home and equity.

Nonetheless, an


in the

Financial Times

on Wednesday asserts that Bank of America,

Wells Fargo

(WFC) - Get Free Report

, JPMorgan and others are turning increasingly to the short-sale tactic. One real estate broker told the


that "if 2009 was the year of the loan modification, 2010 will be the year of the short sale," while a Bank of America representative said short sales are now outpacing foreclosures, calling it a "new development."

While the short-sale wave forecasts more residential real estate pain, maybe it's not such a bad thing after all. Instead of masking difficulties through mark-to-market maneuvers or ineffective workout programs, banks will start facing up to full losses, and homeowners will admit that they might have been better off renting. The reckoning had to come eventually, and then, maybe, the housing market can begin to truly improve.


Written by Lauren Tara LaCapra in New York