Foreclosures Are the Solution, Not the Problem

NEW YORK ( TheStreet) -- Former Federal Deposit Insurance Corp. Chairman Sheila Bair made some excellent points in her Washington Post Op-ed piece Monday but overlooked one important point: The U.S. needs to double down on foreclosures.

To the former regulator, forgiveness is the answer. Bair said that the banks had showed a "stubborn refusal to deal head-on with past-due and underwater mortgages," and that it was "time for banks and investors to write off uncollectible home equity loans and negotiate new terms with distressed mortgage borrowers that reflect today's lower property values."
FDIC Chairman Sheila Bair

True enough.

But why should the banks automatically write off any second-mortgage or home equity line of credit that goes delinquent? If word were to get out, any borrower who was actually in a position to comfortably make their first mortgage payment, plus a payment on a second mortgage, would seriously consider a "strategic default." They wouldn't lose their homes under Bair's plan.

Bair does place some blame on consumers, saying that leading into the credit crunch, "it became old-fashioned to save up for the down payment on that first home," and that "taking out a mortgage shifted from the most serious financial decision a family would make to a speculative bet on how far home prices would rise."

No, ramping up writedowns isn't the only answer. Want to save the banking system and restart the housing market. Why not also step up foreclosures?

Foreclosure has become a dirty word, but the regulatory onslaught has forced the largest banks to improve their loan servicing and foreclosure practices, and deals such as the recent $8.5 billion mortgage putback settlement by Bank of America ( BAC), actually spell-out myriad servicing, modification and foreclosure processing improvements.

So this is the time for banks to really push the foreclosure process, and maybe regulators and the rest of Washington crew consider process reforms to speed foreclosures through the courts.

Banks not only need to beef up their loan-modification efforts -- as Bair suggests -- but also greatly increase their mortgage foreclosure filings. Rather than taking a uniform approach, like Bair's brilliant write-off of any "uncollectable" second mortgage, the banks need to analyze each delinquent loan and make the decision that best services the bottom line.

Either way, it enables them to move forward and clear out the volume, thus helping the overall housing as well.

Here's a quick rundown of the quality of modified mortgages at the "big four" U.S. banks. It may seem a bit tedious, at first, but the numbers clearly show that modification isn't always the answer.

Bank of America

According to the Consolidated Financial Statements for BHCs (FR Y-9C) filed with the Federal Reserve, America's largest bank had $66.4 billion in delinquent one-to-four family residential loans as of March 31. That number includes second mortgages and home equity lines of credit, but excludes construction loans.

By "delinquent," we mean a loan for which payments are at least 30 days past due or have been placed in nonaccrual status, because the lender doesn't expect to be repaid principal or interest.

Bank of America had $16.4 billion in modified one-to-four family mortgage loans as of March 31, and of that total, $7 billion were reported as not being current, per the modified loan terms. This means that for 43% of the modified mortgage loan balances on Bank of America's balance sheet as of March 31, the borrowers had defaulted again.

Such a high rate of second defaults shows that the banks cannot take a uniform approach to modifications. Each loan must be assessed -- hopefully quickly -- so that the lender can decide whether to go through a process of up to two years, during which the borrower may be living "rent free" while possibly allowing the property to deteriorate.

Then again, maybe the borrower has already vacated. Despite the huge decline in property prices, foreclosure may still be the best way to go. After all, for that 43% that defaulted a second time on Bank of America, home prices may have declined much further since the loan was modified.

For the remaining members of "the big four" club, the numbers aren't quite as stark, although there have been a lot of second defaults among the modified:

Wells Fargo ( WFC) ranks fourth among the "big four" by total assets, but places second, with $51.4 billion in delinquent one-to-four family mortgage loans as of March 31. The company had $13.9 billion in modified one-to-fours on the balance sheet, with 33% having gone into default again, as of March 31.

JPMorgan Chase ( JPM) is next, with $39.7 billion in delinquent one-to-four family mortgage loans as of March 31. The lender had $25.7 billion in modified one-to-fours -- the most on the balance sheet for any U.S. bank holding company -- and 27% of those had become delinquent again.

Citigroup ( C) had $17.9 billion in delinquent one-to-four family mortgage loans on its balance sheet as of March 31. The company had $18.9 billion in modified one-to-fours, and of these, 30% had gone into default a second time.

Bear in mind that these numbers only represent the loans actually on the banks' balance sheet. Bank of America alone was servicing $1.4 trillion in one-to-four family residential mortgages for others, as of March 31, and of that total, $96.9 billion were in some stage of foreclosure.

-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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