Barney Frank wants $442.1bn from banks | FT Alphaville

Barney Frank wants $442.1bn from banks

And he wants it from these four: Bank of America, Wells Fargo, Chase and Citi.

The chairman of the House Financial Services Committee wrote to the heads of the four banks on Monday, asking the banks to write down their second-lien mortgages in order to save US housing.

Here are some excerpts from the letter, via Zero Hedge:

To save homes on a large scale, we must move past temporary modifications in interest rates or terms and focus on permanent principal reductions that result in truly sustainable mortgages . . .

Large numbers of these second liens have no real economic value – the first liens are well underwater, and the prospect for any real return on the seconds is negligible. Yet because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans, which would allow willing first lien holders to reduce principal and keep borrowers in their homes.

The four organizations you lead are major participants in the second-lien market. Failure to modify these debts has become a major and unnecessary obstacle to thousands of Americans being able to stay in their homes. I urge you in the strongest possible terms to take immediate steps to write down these second mortgages and allow principal reduction modifications of the underlying first liens to take place. If there are legal obstacles to your doing so, we will work with you to remove them.

Readers of FT Alphaville will know that second liens are something of a sticking point for the US government’s housing aims. The biggest problem is the fact that they act as an obstacle to modifying floundering schemes such as the Home Affordable Modification Program, i.e. altering them to include principal reduction for underwater homeowners, rather than just forbearance.

Frank seems to be suggesting a concerted move towards principal reduction — something which is practically impossible without banks accepting losses on their second-lien mortgages. The issue is that under current subordination rules first-lien mortgages can’t be written down before the second — something which would have to happen if principal forgiveness came into play.

On Monday, the Treasury also mentioned to Huffington Post’s Shahien Nasiripour that it was discussing principal reduction — though a spokesman for the Department later reneged on the statement.

Either way you look at it though, momentum towards second-lien write downs does not bode well for banks, and it makes for a sticky situation for the Treasury too.

We’ve printed this chart, from Amherst Securities, before, but it’s worth doing again:

The Treasury can’t force banks to write down the value of their second-lien mortgages without eating into their capital. It also cannot force them to write down mortgages much beyond the levels at which they’ve been publicly stated, without making all the banks look like outright mark-to-make-believers.

Mike Konczal at Rortybomb has already pointed out the second issue, in relation to the US bank stress tests which took place in the spring of last year. Where Frank says second-lien mortgages are essentially worthless, during the tests the top four banks look to have claimed they expected losses of between 13.2 and 19.5 per cent — or about $68.4bn.

Contrast that with $442.1bn, which would be assuming the admittedly unlikely event of total losses on all the loans, and you have something of a discrepancy in those second-lien values.

The truth probably lies somewhere in the middle, but note that in May 2008 even Moody’s were expecting losses of 17 per cent, 42 per cent and 45 per cent for 2005, 2006 and 2007 subprime second-liens, respectively.

(Also worth checking out Bruce Krasting, who points out there may be a touch of hypocrisy to Frank’s latest missive, considering the US government’s willingness to prop-up subordinated debtholders elsewhere.)

Related links:
Shadow bank losses – FT Alphaville
A second (lien) helping of Hamp – FT Alphaville
Principals, forgiveness, and a reborn Hamp? – FT Alphaville
Second-lien fallout – FT Alphaville (May 2008)