How Zombie Banks are Ruining the Future

Thursday, August 5, 2010
By Paul Martin

James Wesley, Rawles

The banks of the world are in a mess, but thankfully they are sorting out their problems.

Except that they’re not

In the boom years, banks gave out more and more mortgages to riskier and riskier home owners, with the understanding that if things turned really bad, these mortgages would be terrible loans that would lose a fortune.

So when things did turn bad and the home owners could no longer pay for the mortgages, these mortgages bankrupted the banks that gave them out.

Except they didn’t

The problem with mortgages for banks is that they don’t know how bad the situation is until they sell the underlying houses. If I buy a house for $300,000 with $50,000 of my own money and a mortgage for $250,000 from the bank, the worst that the bank is expecting is that if housing prices go down to $250,000, then the bank can foreclose on the mortgage (chuck me out) and sell the house to get back the amount of the mortgage. I’ll lose my $50,000, but the bank will get back its $250,000 and come out even.

So what happens if the housing market goes so bad that the house is now only worth $200,000? In theory, the bank sells the house and loses $50,000 itself, and I lose my $50,000, and we both move on poorer but wiser. [JWR Adds: In actuality, if the foreclosure sale results an a $200,000 price, then, in theory, the homeowner loses $100,000 and is still obligated to repay the $50,000 shortfall to the bank. (One exception is in states with “non-recourse” loan laws.) But from a practical standpoint, this doesn’t always happen, even where it is the law.]

Except that the bank doesn’t sell

The Rest…HERE

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