The only argument for not forcing banks to take serious write-downs on second-lien loans is the assumption that housing prices are going to return to pre-2007 prices. And that is not going to happen unless we have another real estate bubble.
Second-lien loan portfolios are among the largest and most precarious liabilities on bank balance sheets today. The four largest banks hold approximately $420 billion of these loans on their books—more than 40 percent of the approximately $1 trillion in outstanding second-lien loans. Housing prices have plunged 32 percent since 2006, and many of the second-lien portfolios will be worthless if the foreclosure crisis continues.
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With millions of American homes in immediate danger of foreclosure and bank solvency still an issue, time is running out to resolve two incompatible agendas that the Obama administration has pursued since it took office.
On the one hand, regulators are allowing “too big to fail” banks to conceal losses, which might reveal that they are insolvent, by allowing these institutions to keep large portfolios of second-lien mortgages on their books at close to pre-bubble values. (Second-lien loans include home equity lines of credit as well as piggyback mortgages—the high-interest loans that were typically used to finance 15–20 percent of a home’s cost.)
One of the biggest holes in HAMP and other loan modification programs is their failure to address second-lien loans significantly. And what makes inaction on second-lien loans especially troubling is that the Treasury Department estimates that 50 percent of at-risk mortgages involve these kinds of loans.