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Insider Scoop on Short-Sales / Foreclosures
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 ForeclosuresWondering why banks are so un-cooperative on short-sales and foreclosures? Why does it take 3 months or more to get bank approval of a great cash offer on a short-sale? Follow the money!

Banks have perverse incentives to hang on to unproductive loans. Sure, some properties are moving thru the pipeline, but only enough to avoid charges of obstructionism. Banks must appear to be cooperative, but the backlog (with the complicity of government) is still horrendous, especially with higher-value properties.

Follow this example – if a loan on a 100K house goes bad and the house is sold for $60k the bank loses $40k. That’s not the worst part.

THE REST OF THE STORY
The magic of banking is that banks are allowed to lend as much as $50 for every dollar in their capital account.*
Writing off $40k means they must forego loaning $2million (50 x $40k).
The interest on $2million at 5% is $100k, so writing that loan down by $40k also costs them $100k in interest, for a total loss of $140k the first year, plus a diminishing $100k per year thereafter.
No wonder banks are dragging their feet and only dribbling out sufficient toxic assets to APPEAR cooperative!

This explains why banks are still incentivized to accumulate toxic loans. They are better off holding bad loans and continuing to lend at multiples of that high phony number, than recognizing the loss. This also explains why troubled investment behemoths (Morgan Stanley, Goldman Sachs) were converted to banks during the Sept-Oct 2008 crisis -- it was the perfect political opportunity to get a quick bank charter and “create new liquidity”.

BOGUS VALUATIONS
None of this would be possible without a little accounting trick. In March 2009 pressure from Obama and CONgress changed the rules promulgated by a group of 5 politically-influenced super-accountants called the Financial Accounting Standards Board (FASB). They now allow three levels of valuation in their Rule 157 that defines how assets must be valued.

1. Lower Of Cost, or Market Value conservative accounting rules used to require valuing assets so that the bad loan showed on the books at $60k to reflect its real market value. That standard is still used for valuing stocks, bonds, gold, anything where an active market produces an easily obtainable market price.

2. Mark to Model got two wizards the Nobel Prize in Economics. Using a lot of fancy calculus that would make your head spin, they claimed the ability to value a portfolio of mortgages according to all the risk factors inherent in that investment. That led to the derivatives cesspool known as Mortgage Backed Securities. When I asked a world-renowned statistician what went wrong, he simply replied “Garbage in – garbage out” – a model is only as good as the validity of its assumptions, and theirs were naive.  When multiple factors all declined at the same time, the model failed". This bogus model is still used for mortgage pools (about 15,000 mortgages) where statistics theoretically apply.

3. Mark-To-Make-Believe values, permitted by loosening FASB Rule 157 in March 2009, makes fairy-tale accounting possible. Lenders can now carry a bad mortgage on their books at values having no basis in the reality of today’s market. They are permitted to make their own assumptions for mortgage payback which would be ruined by taking the loss. CONgress does not deal with the real world, so this kind of accounting makes perfect sense to them.

 

HONESTY IS ESSENTIAL
America grew to a powerhouse because of honesty - more than anywhere in the world.
Honesty was the lubricant that made free enterprise run smoothly.
Without honesty there is friction, and government steps in to gum up the works.
Honest balance sheets are an essential component of lending.
Playing games with the rules (dishonesty) erodes confidence, and people’s willingness to buy or invest.
If the political elites understood economics and set aside their own greed, they would just flush the toilet on bad loans and make-believe financial statements; then we could get on the road to recovery.

FUTURE IMPLICATIONS
In classical economic theory pumping trillions in fiat cash into the economy would result in inflation. But it has not happened, even when looking at REAL inflation versus the manipulated number publicized. The inflation-adjusted GDP (total value of goods and services produced) and the Labor Force Participation Rate (a better measure of economic health) are declining despite rising stock market indices. Why? Economist Milton & Rose Friedman defined inflation as too much money chasing too few goods. The operative word is CHASING! Banks are unwilling to lend to other banks or businesses when they know their own balance sheets are full of fluff, so logically everyone else's must be even worse. They can't trust the financial statements, so they have not been lending. There is no multiplier effect, thus no CHASING. Instead, big banks and "investors" bet on derivatives and that bubble has grown to $630 trillion dollars (updated 2014) in face value (plus unreported private contracts) on phony balance sheets. For perspective, the value of all the real estate in the world is estimated at $50 trillion. The bubble WILL burst.

______________

PostScripts:
See The Great American Bank Robbery
Video - Lecture at the Hammer Institute
By William K. Black, a liberal regulator who details the failure of regulation.

Dump the Debt! Default is the Responsible Alternative

 

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