Banks Are Unwilling to Solve REO Problems

Apr.12.09 | About: iShares U.S. (IYR)

Tim Iacono writes about an article that appeared in the San Francisco Chronicle. I have seen similar stories elsewhere over the past few weeks. The following is from the article:

"We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market," said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. "California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You'd have further depreciation and carnage."

Banks who hold these homes are in a position to sell them if they want to. The answer to selling at least some of these homes is simple: PROVIDE SELLER FINANCING.

The reason that the homes are not selling is that loans are not available to a wide swathe of Americans who can and want to purchase a home either to live in or as an investment. One hundred percent financing at reasonable rates could solve the problem. The sales could be to investors or to borrowers who occupy the homes.

What do the banks have to lose? The loans have already been written off their books, and the assets in REO status are carried at some discount to market value. If banks were to sell the homes with seller financing, buyers would take care of them to avoid further depreciation. Prices in these seller-financed transactions would be significantly higher than in other types of transactions. Over time, assuming a market recovery of some kind, owners would refinance or sell their homes to others, satisfying the seller-finance notes. If some buyers default, then the banks can simply repossess those homes and they are no worse for wear. Keep in mind in this regard that a vast majority of mortgage loans, even subprime loans, are not in default.

This approach would take no additional outlay of bank capital. In addition, at today's low interest rates, banks and borrowers could recognize significant principal payments in short order. Performing notes could be put back on the banks' balance sheets after some period, or sold to investors or other banks. I understand the objections to making loans to risky borrowers, but the losses here are already fixed. There is no further downside risk.

The alternative that the banks are choosing is to sit on their hands and their money. Empty homes are deteriorating in value as the banks try to time the market and to avoid making loans for some reason I do not fully understand. The damage is done. The banks hold at least part of the solution and are refusing to take reasonable actions to ameliorate their problems.

Disclosure: No position.