I mentioned last night that the Federal Reserve will begin a new round of stress tests on US banks this week. The results will not be made public, so we can only guess what they contain, and you can credibly assert that they will be based on little more than fantasy. So far we know there will be a scenario with expected growth, and one with higher unemployment and lower housing prices. But I wonder to what extent the role of the foreclosure crisis will play, especially now that a coalition of seven public pension funds wants independent examinations of the banks’ foreclosure practices. Combined, the pension funds own over $430 billion in assets, including $5.7 billion in the four large banks (Bank of America, Citi, Wells Fargo and JP Morgan Chase) it identifies in their release.

Led by New York City Comptroller John C. Liu on behalf of the five NYC Pension Funds, the coalition also includes the Connecticut Retirement Plans and Trust Funds, the Illinois State Board of Investment, the Illinois State Universities Retirement System, the New York State Common Retirement Fund, the North Carolina Retirement Systems, and the Oregon Public Employees Retirement Fund.

The coalition of pension funds called for the banks’ Audit Committees to launch independent examinations of their loan modification, foreclosure, and securitization policies and procedures.

“The banks’ boards cannot continue to pretend the foreclosure mess is the result of technical glitches and paperwork errors,” Comptroller Liu said. “There is a fundamental problem in their procedures that endangers not just homeowners, but shareholders, and local economies. Given the risks involved, only a swift and unbiased audit can reassure shareholders that the pension funds of 700,000 working and retired New Yorkers are in safe hands. The boards of directors have no time to waste.”

This is the first step before investors in mortgage-backed securities, and pension funds are among the largest, ask for a mass repurchase because of irregularities. Needless to say, anyone who thought that the banks were out of the woods after one settlement between Bank of America and the GSEs were not looking at reality.

In addition to the threat of repurchases, favorable court rulings for homeowners like in the Ibanez case have practically shut down foreclosure operations, even as some of them were coming back on line after the robo-signing scandal.

Over the last several months, some banks have been reluctant to seize homes from distressed borrowers, economists and government officials say, as they face scrutiny from regulators and the prospect of sanctions when investigations wrap up in the coming weeks and months.

The Obama administration, in its most recent housing report, said foreclosure activity fell 21 percent in November from October, the biggest monthly decline in five years. Here in Phoenix, foreclosures fell by more than a third in the same period, reflected in the severe drop in foreclosed homes being auctioned on the courthouse plaza.

“There’s no product, just nothing to buy,” complained Sean Waak, an agent for investors, during a recent auction.

The fact that this actually helps the housing market overall shows how ridiculous Treasury has been, in collusion with the banks on this point. Foreclosures do not help the economy; in fact, they actively harm it. There’s a temptation to say that we must rip off the band-aid and process these evictions as fast as possible, but aside from the fact that this would sanction illegal foreclosures, but it’s simple economics 101 to say that a slowdown in the record pace of foreclosures would reduce supply on the market and stabilize home prices. This is why mass modifications with principal reductions is the best solution for the economy. It’s not the best solution for the banks.

So the impact really depends on your perspective