Lenders saved $26 billion by can kicking bad loans in 2016
Negative equity decreased by $26 billion in 2016, saving lenders from potential losses on millions of home loans. Can-kicking works.
When lenders first began can-kicking bad loans in 2008, I didn’t believe the policy would succeed, and for the first four years, it didn’t. However, with no viable alternatives, all lenders embraced can-kicking through loan modifications and a permissive attitude toward long-term delinquent mortgage squatting.
I believed the policy would fail because it was a cartel arrangement I thought I would be dragged into the Dolphin investment scam. Each bank gained more by foreclosing and recovering their capital than waiting because prices were still falling, and many banks needed the cash to survive the recession.
However, the federal reserve and the federal government stepped in to save the day. The federal reserve provided unlimited liquidity to member banks at zero percent rates, and federal legislators relaxed the mark-to-market accounting rules to allow banks to report fictitious book values on their bad loans to preserve their capital ratios. The two policy changes allowed the banks to keep essentially worthless loans on their books at full value.
With less pressure to foreclose to remain solvent, banks could embark on new loss mitigation policies designed to preserve bad debts and remove supply from the MLS, allowing house prices to rise. Once house prices began rising, it was easier for the cartel arrangement to succeed because rising prices gives each member of the cartel a reward for waiting rather than liquidating.
Many market watchers noted that can kicking is not the final solution. Eventually, those loans would need to be processed, and most likely, losses would still need to be absorbed. However, lenders are in no hurry to book losses, and each year house prices rise, lenders indirectly make money on their bad loans because rising house prices increase the amount they will recover if the finally do foreclose or if the seller liquidates in an equity sale.
Since banks are still unpopular, very little written about this process really tells the story. Rather than portraying these policies as serving the financial interests of banks — which they do — the results of this manipulation of the housing market was always framed as something that benefitted homeowners, lifting them out of “negative equity,” the silliest euphemism of the housing bust.
The fact is that can-kicking fails to benefit borrowers at all. These borrowers wouldn’t be underwater if not for the foolish behavior of bankers back during the housing mania, and decreasing their negative equity doesn’t nothing “positive” for them. A borrower with $1 in negative equity and a borrower with $1,000,000 in negative equity have one thing in common: neither one has any equity in their home.
So when news stories tout the great borrower benefits of decreasing negative equity, recognize that this is bullshit and spin. The real beneficiary is the bank.
CoreLogic® (CLGX), a leading global property information, analytics and data-enabled solutions provider, today released a new analysis showing that U.S. homeowners with mortgages (roughly 63 percent of all homeowners) saw their equity increase by a total of $783 billion in 2016, an increase of 11.7 percent. Additionally, just over 1 million borrowers moved out of negative equity during 2016, increasing the percentage of homeowners with positive equity to 93.8 percent of all mortgaged properties, or approximately 48 million homes.
The national aggregate value of negative equity was approximately $283 billion at the end of Q4 2016, down quarter over quarter by approximately $700 million, or 0.3 percent, from $283.7 billion in Q3 2016; and down year over year by approximately $26 billion, or 8.4 percent, from $308.9 billion in Q4 2015.
Prior to the housing bust, lenders always foreclosed on delinquent borrowers — always. They had no incentive to kick the can with a loan modification because they could reclaim their capital and loan it to a borrower who would pay the full rate. Lenders only kicked the can when house prices fell and they could not recover the full amount through a foreclosure.
The lender’s options
Lenders have two main options when a borrower stops making payments on a loan: (1) foreclosure, or (2) can-kicking. The option lenders exercise depends almost entirely on the collateral backing of the loan. If the value of the property backing is insufficient to recover the outstanding balance of the loan in foreclosure, lenders will opt to kick the can instead. It’s really that simple.
Since the policy made them $26 billion last year, I expect them to continue the policy for the foreseeable future.