The SEC is investigating bank practices that seem to have been enacted with the blessing of the Fed and Treasury: Extend & Pretend.

Many of the bailouts, mortgage mods and behaviors we have today exist to serve a single purpose: To allow the banks to kick the can down the road as far as they possibly can when it comes top their dual portfolio of bad mortgages and bank owned Real Estate (REOs).

Consider how ironic this is: From the GSEs becoming a dumping ground for every crappy mortgage to the failed policy of HAMP/mortgage mods, to the arbitrage between the the Fed’s ZIRP policy and Treasury’s 10 year bonds, nearly every reaction to the financial crisis has been a willful, concerted effort to kick the can down the road.

Rather than go Swedish, and force a shorter painful pre-packaged bankruptcy process, we have opted to take the long slow route:

1) Banks are slowly rebuilding their capital by borrowing from one branch of government and lending to another. This is a slow process, but its less well unerstood (and hence more politically acceptable) than merely giving Banks capital outright.

2) FASB 157 allows banks to carry all of these structured products made of bad mortgages on their books indefinitely.

3) Banks are carrying lots of housing inventory waiting for a better residential market to emerge 5 or 10 years down the road.

Under normal circumstances, the bad mortgage process goes Delinquency (late payments) Default (90 days behind), Foreclosure (legal proceedings to enforce the note).

Once a home goes into foreclosure, the accounting changes: It is now a loss that must be written down immediately. That hits the banks capital levels. Consider what the next 3-5 million foreclosures will do to banks’s capital cushions.

Once a foreclosure occurs, not only does the capital write down take place, but the local property tax liability accrues to the bank; prior to foreclosure, the liability is to the nominal home owner and/or property. Once the bank takes possession, its on them.

Hence, you can see why “Extend & Pretend” is so attractive to the large institutions sitting on massive REO inventory, enormous bad loans and CDOs, and huge future local tax obligations.

I wonder: How many bad loans are on the books as either performing or in modification when they are nothing of the sort? What are Citi, Bank of America, Wells Fargo and even JPM carrying that are misrepresented on their balance sheets?

Lastly, consider this: If banks had to accurately report their balance sheets, if they were required to give a full and honest accounting,many of these institutions would be declared insolvent.

We are now in a race to see what will come first: The next regained health and stability of our incompetently run banking sector, or the next crisis.

Place your bets! The trifecta of bad loans, easy money, and lax regulations begins a new every decade!

>

Previously:
Fair-Value Accounting & FASB 157 (September 30th, 2008)

Time to Get Swedish (January 23rd, 2009)

See also:
SEC Probe Examines Bank-Loan Practices (WSJ)

Officials Disagree on Penalties for Mortgage Mess (NYT)

Category: Bailouts, Credit, Real Estate

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

28 Responses to ““Extend & Pretend” Practices Attracting SEC Scrutiny”

  1. JimRino says:

    Rewarding Failure, allows Wall Street to afford to prop up the “Republican” party.
    Failure rewarding failure..

  2. Petey Wheatstraw says:

    “3) Banks are carrying lots of housing inventory waiting for a better residential market to emerge 5 or 10 years down the road.’

    The might as well be waiting for Jesus to come back.

    From PA to GA there are thousands upon thousands of homes — new and previously occupied — being left to molder. I’ve driven the towns and back roads, and I’ve seen it all.

    Every now and then, someone on the internets tubes will suggest that unoccupied houses be bulldozed in an act of “creative destruction.” In a sense, that’s already happening, only Mother Nature is being allowed to do very slowly what the dozer would do in a matter of minutes.

    Recently nice/occupied homes missing shingles and/or siding due to weather. Windows broken and letting in the rain and snow. Downspouts eroding soil away from foundations. Gutters pulled down by the weight of rotting leaves. Trees, grass, and critters encroaching on lawns.

    Inside, appliances and fixtures have been taken or simply trashed and left behind, along with anything the previous occupant didn’t want to move, including trash and rotten food. Walls have been smeared with food (and probably feces).

    Many of these houses are REO, but not on the market. Many are already in such poor shape that they will never be sold. Even houses on large chunks of acreage (10+), the only value left is in the land, and any developments (well, septic, electric and other utilities — including the ubiquitous satellite TV dish), won’t find a buyer because the structures themselves have become a liability and a barrier to the sale of the property, as tear-down is required in order to replace a dangerous structure with a habitable one.

    Extend and pretend has a result that the SEC can’t reverse.

  3. SCTTD says:

    John Hussman had somewhat scathing comments about status of FASB 157 and the Boards unwillingness to actually hold their constituents to a reasonable standard in this weeks commentary.

    http://hussmanfunds.com/wmc/wmc110228.htm

    Scroll down to the open letter to the Financial Accounting Standards Board section.

  4. Surprising to think that anyone in the investment community believes that the banks are not intentionally “kicking the can down the road” – of course they are.

    In fact, this is explicit government policy: is not a major reason for Federal Reserve’s negative real interest rates to help recapitalize the banks so that they will eventually be able to write off the remaining bad debt?

    Also, by “going Sweedish”, do you mean a Mises-like clearing out? I would have thought that “going Sweedish” would conflict with the left of center agenda, no?

  5. this: “1) Banks are slowly rebuilding their capital by borrowing from one branch of government and lending to another. This is a slow process, but its less well unerstood (and hence more politically acceptable) than merely giving Banks capital outright…”

    as an explaination of: “…the arbitrage between the the Fed’s ZIRP policy and Treasury’s 10 year bonds…”

    is complete, and utter B*******.

    for further reading…

    http://www.humblelibertarian.com/2009/08/77-reasons-to-audit-fed-and-end-fed.html
    http://www.monetary.org/federalreserveprivate.htm
    http://www.barefootsworld.net/banking-fed-quotes.html

  6. SCTTTD –

    Talk about scandalous accounting: remember that Buffet did not use mark to market accounting on a portfolio of publicly held securities and was able to get away with it with a mere verbal slap on the wrist from the SEC….

    http://alaricinvestments.blogspot.com/2010/10/us-is-banana-republic-part-2.html

    Shocking?

  7. curbyourrisk says:

    Mark…when you say that is B********…do you mean the act is B******, or you do not believe it?????

    For the GSE’s….give me a call….I have a crap mortgage you have as well.

  8. curbyourrisk says:

    Forget going swedish. Let’s all go Iceland on their asses.

    Collective middle finger to the banks….

  9. constantnormal says:

    “2) FASB 157 allows banks to carry all of these structured products made of bad mortgages on their books indefinitely.”

    Indefinitely? Surely not forever … what happens when these toxic mortgages mature, and still have huge unpaid balances?

    Don’t they have to be written down then, or can they continue to be carried on the books as “assets”, with a mountain of “good will” in the form of unpaid principal & interest, penalties, and fees?

    Why do the banksters EVER need to work again, if they can mine nothingness in perpetuity?

  10. KentWillard says:

    I think the SEC’s focus is on the largely forgotten commercial real estate (perhaps construction too), not single family mortgages. Although commercial real estate prices have fallen almost as much as house prices, we haven’t seen the spike in defaults (yet?).

    The bigger question is why the SEC is pushing this rather than the obvious regulators: OCC and FDIC. Would be interesting to know if all the SEC Directors support this action, or if it is a partisan choice.

  11. constantnormal says:

    Mary Shapiro is gonna get herself in a lotta trouble, if she’s not careful … this is what happens when the head of a regulatory agency is not a former bankster …

  12. curb,

    if I’m reading that, correctly, the GSEs aren’t involved in this statement: ““…the arbitrage between the the Fed’s ZIRP policy and Treasury’s 10 year bonds…”

    and, to restate/try to clarify, this : “1) Banks are slowly rebuilding their capital by borrowing from one branch of government and lending to another. This is a slow process, but its less well unerstood (and hence more politically acceptable) than merely giving Banks capital outright…”

    as an explaination of: “…the arbitrage between the the Fed’s ZIRP policy and Treasury’s 10 year bonds…”

    is complete, and utter B*******.

    or, differently, the idea that the FedRes is a ‘branch of Government’, akin to the Legislature, Executive, and Judiciary is, quite, inane..

    http://www.thefreedictionary.com/inane

  13. b_thunder says:

    I bet the next budget will have SEC defunded even more than the wettest GOP dream would be.

    But this time it will be courtesy of the Obama/Dudley/Geithner cartel.

  14. wally says:

    “Banks are carrying lots of housing inventory waiting for a better residential market to emerge 5 or 10 years down the road.”

    A self-defeating act; they’ll be a drag on the very market they hope will improve.

  15. curbyourrisk says:

    Mark…my GSE comment was not related to your comment at all…..just something completely different.

    As for the rst of your comment……… The FED RESERVE has been controlled by the government for some time…effectively making a exetnsion of a branch (or multiple branches) of government.

    If you do not believe that the actions taken are not complicit in allowing the banks to mock america and fill their coffers at our expense, then you sorely are mistaken….

  16. stopGOVTwaste says:

    stopGOVTwaste
    stop_govt_waste@hotmail.com
    68.205.104.52
    2011/03/03 at 9:38 am

    I thought the banks wanted defaults… so they can obtain the Credit Default Swaps, right?

    Isn’t this why they tell people to stop making payments (must be 90 days late in order to receive assistance)?

    ~~~

    BR: You have spammed this blog repeatedly with off topic comments and irrelevancies to promote your own site.

    I allowed this comment to point out what a clueless arse you are. Please stop spamming this blog with your nonsense.

    Go away

  17. curbyourrisk says:

    Barry…can’t you block his IP or something? It’s your site…. I hate to say it, but give Karl Denninger a call, I am sure he can walk you through blocking people.

    Did i just seal my own fate?

  18. curb,

    you know, HTML ‘hyperlinks’ are a wonderful thing, but, like most others “…if you use them.”..

    though, to be clear, you’re correct that the FedRes, and the USG, is a Duopoly… as you would have seen pointed out, here http://www.monetary.org/federalreserveprivate.htm , at the min..

    http://www.tedmontgomery.com/tutorial/hyprlnks.html FFR ..

  19. jaymaster says:

    You could also add number 4: Intentionally manufactured inflation.

  20. [...] Barry Ritholtz breaks this thing down. Please go read the entire post. Here’s a snippet: Many of the bailouts, mortgage mods and behaviors we have today exist to serve a single purpose: To allow the banks to kick the can down the road as far as they possibly can when it comes top their dual portfolio of bad mortgages and bank owned Real Estate (REOs). [...]

  21. partimer1 says:

    That was remarkably accurate about the current affair in economics in this country. How is this different from the lost decades of Japan or Japan Syndrome?

  22. ottnott says:

    Is there anything more typically American than “short-term gain, long-term pain”?

    What’s worse is, that when the long-term pain is being felt, few draw a connection between the pain and the decision in the past to go for a short-term gain.

    A case in point is the supposed “pension crisis”. There are declining cities with a genuine crisis, but many of the states with problems can trace a large part of the problem to past government decisions to underfund pension plans so that they could cut taxes. Now that the bill comes due, the problem we hear about is the pensions, not the decision to skimp on contributions.

  23. bdw says:

    Barry:

    Some states such as Arizona, California, Oregon, and Virginia are beginning to mandate recording of documents showing clear title to real property. If a percentage of the extend and pretend scenarios are the result of notes being lost or separated from the mortgages, won’t these clear title recording bills encourage the banks to cut a deal with borrowers to avoid producing documentation and paying property taxes? Another scenario would be for the banks to get deeds in lieu given to a subsidiary so they could keep the original mortgage or deed of trust “whole” and on the books.

    Thanks for your great blog.

  24. Sunny129 says:

    ‘Lastly, consider this: If banks had to accurately report their balance sheets, if they were required to give a full and honest accounting,many of these institutions would be declared insolvent.’

    This is an OPEN secret since March of 2009! No body cared and NO ONE DID ANYTHING!

    But Now,

    Why all of sudden this HULLABULLOO???????????????

  25. Sunny129 says:

    There are TWO kinds of Accounting standards out there, thanks to gutless FASB!

    For the lender : M to Model/Fantasy standard where LOSS means it is Profit by ‘their’ definition!

    For the Borrower/Home Owner : M to Market standard. Although the MBS security containing his home loan reflects the peak value at 2006, now RE evaluation is at M to M in 2010!

    B/w which accounting standard in OPERATION during the hay days of Housing bubble and Market peak in Oct 2007, with Banksters bonuses calculated on the basis of asset (inflated) values?

    Hello! Market TO MARKET accounting!

    The whole FIRE Economy is FAKE in 2011!

    The CHARADE continues!

  26. josey says:

    BR (or anyone else)- Question:

    You state: “…Once a foreclosure occurs, not only does the capital write down take place, but the local property tax liability accrues to the bank; prior to foreclosure, the liability is to the nominal home owner and/or property. Once the bank takes possession, its on them…Hence, you can see why “Extend & Pretend” is so attractive to the large institutions sitting on massive REO inventory, enormous bad loans and CDOs, and huge future local tax obligations.”

    How does this wash with foreclosure fraud and robo-signings? If banks take a hit if they foreclose, why do it, and do it whereby they open themselves up to a potentially huge legal liability?

  27. Herb2 says:

    If the county were to force the sale of properties as a result of unpaid taxes, would that not force the banks to admit ownership and make them responsible for the RE taxes? Surely the lost revenue will eventually become part of the political battle for funding of schools, police, fire departments, et al.
    A local house is on the counties records as having been built in 2006, but it has yet to pay any RE taxes, apparently because it has never been officially sold, but I’m sure the bank and developer expects police and fire protection.

  28. [...] Bank stocks are not reporting their books accurately. FASB 157 allows them to hide bad loans. The Extend & Pretend approach is well [...]