Oh, The Truth Is The Banks Are Insolvent? (Still)

The Market Ticker

Gee, what have I been saying now for over two years?

Jan. 19 (Bloomberg) — The U.S. Treasury Department has failed to win agreements to get struggling borrowers’ home- equity debt reworked, among the biggest roadblocks to reducing foreclosures that may reach a record 3 million this year.

None of the lenders holding a combined $1.05 trillion in the debt has signed contracts requiring participation in the second-mortgage modification plan announced eight months ago. The largest banks remain “committed” to joining, Meg Reilly, a department spokeswoman, said in an e-mail.

Amusing. My view as expressed somewhat-recently on this issue can be found here:

They are sitting on over a trillion of dollars of this paper (about $1.1 trillion to be exact) and several hundred billion is severely impaired or even worthless. Wells Fargo, just as one example, has (as of its last 10Q) $106 billion of second lines outstanding on balance sheet, and God only knows how much in SPVs (Wells is known to have significant off-sheet exposure “inherited” from Wachovia.) Let me put this in perspective for everyone.

Uh huh.

RealtryTrac says that three million foreclosures are likely this year and that as much as 23% of all mortgages are currently in negative equity – that is, any second line is severely impaired on that property and may be worthless.

All the BS and games has not changed a thing. The big banks all claim to be “committed” to working with the Treasury on these programs, but the fact of the matter is that if they are forced to recognize reality they are insolvent.

But the conundrum is that in order to normalize the economy and lending environment we must stop playing games with home prices. House prices must contract to where average Americans can afford to buy them without using exotic and tricky loans.

HAMP fails to do it – as Mark Hanson Advisers has noted there is no fix in the HAMP program as total DTIs – that is, total amount of debt service as a percentage of GROSS income – remains solidly in the unsustainable area.

As far back as the first few Tickers, dating to April of 2007, I wrote on the fact that sustainable loans are written on a 28/36 basis – that is, 28% DTI for housing expenses and a total debt-to-gross-income ratio (DTI) of no higher than 36%.

Treasury’s HAMP is still resulting in DTIs, on average, of 55% and while this is an improvement over the impossible-to-service 72.2% a 55% DTI is still impossible to service if there is even the smallest challenge in the borrower’s life.

Remember, these DTIs are computed on gross income – that is, before both state and federal income and other taxes. Further, it is widely agreed and understood that tax rates are at generational lows and as such the tax bite will only increase in years to come.

The bottom line? The banks are still insolvent, Treasury is still lying, the banks are still refusing to recognize losses that have already happened and all of this together will prevent any meaningful recovery the broader economy from taking hold.

We should have forced all of these banks through insolvency in 2007 and gotten it over with. We still can and should. The institutions that wrote these loans were radically irresponsible and protecting them from the consequences of their idiocy has provided only a temporary respite from the underlying reality – the amount of debt in the marketplace exceeds the ability of those who earn incomes to service it.

Until we face reality any alleged “recovery” is a chimera created by ever-increasing allowance of and reliance on fraudulent accounting, not fundamental improvement.