The Mystery of Banks Not Helping Containment of Foreclosures by Agreeing to Short Sale

May 22nd, 2009 | Tags: Foreclosure

It is really a mystery as to why banks are not helping containment of foreclosures by agreeing to short sale. In a short sale the lenders avoid the costly process of foreclosure and the borrower escapes the stain on credit history – something inevitable in a foreclosure. In a foreclosure the banks lose 40% whereas in a short sale the loss for the bank is 19%. If so why are the banks no cooperating?

The problem is securitization and the sheer number of foreclosures. The banks do not have the infrastructure to attend promptly to each and every application for short sale. By the time they haggle and agree the foreclosure process has most probably started. One department of the bank is not in tune with the other – thanks to the sheer volume of the problem. Only 23% of short sales reach the final stage according to Campbell Communications.

The Congress is also baffled by this issue. Rep Brad Miller (Democrat) points to the securitization of loans as being the culprit for this impasse. The mortgages were bundled into packets and then sliced into ‘tranches’ before being sold off to various investors across the globe. These investors collect their gains in a pecking order. The senior ones get paid back first and hence in the case of a loss the juniors get nothing. It is the latter who are up in arms against short sales since they will get nothing but the seniors will get something.

Miller said, “The people with the least senior tranches have no reason to agree to the modification because they take a complete loss and the people in the most senior tranches don\’t lose anything. So they\’ve managed to structure their mortgages in a way that makes it almost impossible to modify or sell short.”

Miller had a hand in sponsoring a legislation that would have allowed bankruptcy judges to alter the terms of certain mortgage loans. It would have taken away the right of the junior investors to sue and encouraged them to negotiate. But very recently the clause died in the House with the active opposition from not only the full Republican bloc but also many of the Democrats. The banking lobby had the last laugh.

Dave Liniger of Re/Max said had the bill been passed the bargaining scenario would have changed. Lenders would have had a greater interest to accept a loss on a short sale rather than permit a judge to pen through drastically the terms of the mortgage.