Our Governments, state and federal, get together in a closed room with the banks that crashed the economy and lied to courts. Then suddenly they announce a settlement, and pour out a load of PR and fly-by press conferences extolling its wonders. So where is the text? We don’t get the text. Now we learn there isn’t one. There isn’t even a written agreement in principle awaiting reduction to a final text. We don’t get to see it until it gets to court.
We have to guess based on self-serving hints from anonymous sources. One reason for the secrecy is probably that the even the partial disclosures show that the deal sucks for homeowners, while banks love it. It will be worse when we see the actual language.
The weasel words we are getting define some areas we know to look for if and when the actual document is released. Here’s how Adam Levitin at CreditSlips describes one part of the deal:
And when a second lien loan owned by the bank is involved, it only has to be written down pari passu (at the same percentage) as the first lien loan. So from absolute to relative priority, which is a major handout to the big banks, which have large underwater second lien positions.
Earlier dday reported that if the second lien is delinquent by more than 180 days, the bank has to write it down to zero.
This is a bailout for the banks as Yves Smith shows here; it’s reason number four of 12 reasons you should hate the deal. The question is whether it helps homeowners. In short, a write-down doesn’t affect the amount the borrower owes. Only if the debt is forgiven does the homeowner benefit.
“Write-down” is an accounting term. It means that the bank has to treat the asset as worth less than the amount shown on its books. Suppose the loan is $1,000. The bank shows the loan as an asset valued at $1,000. If something happens to make it less likely that the entire amount will be collected, the bank shows it at the amount it estimates it will eventually collect, or an amount acceptable to its regulators. The difference is an expense for the bank.
Banks know that there will be losses on their loans, so they set up reserves for loan loss on their books. Additions to the reserves are an expense to the bank, and reduce earnings. Then when they actually incur a loss, they might treat that loss as a reduction in their loan loss reserve account rather than a loss at that time. When the losses pile up faster than expected, they have to increase the loan loss reserve account, again as an expense, reducing profits. From time to time, banks reduce their loan loss reserves on the grounds that they are too high. That is treated as income on their books. Here’s a more detailed description of loan loss reserves.
The term “charge-off” has the same meaning. It’s an accounting term, used more often with credit card accounts.
Neither write-offs nor charge-offs affect the obligation of borrowers. They still owe the entire amount. The bank can continue to hound them for money. Or, the bank can sell loans to a bottom-feeder for a percentage of their face value, and the vulture can peck the cash off the borrower’s bones.
Forgiveness is another matter entirely. The settlement requires some principle forgiveness on the part of the first lien holder. That is money that the borrower doesn’t owe anymore. It can’t be collected from the borrower or a guarantor, the bank can’t charge interest on the amount forgiven, and the bank can’t sell that part of the debt to a vulture.
The problem with forgiveness for the borrower is that the amount forgiven is taxable income to the borrower with certain exceptions. One of those exceptions is for mortgage debt relief. If the debt forgiven relates to one’s principle residence, the forgiven debt is excluded from income, at least through 2012. Unfortunately, the settlement takes effect very slowly, so this exclusion will disappear for many unless extended by Congress.