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On 7 million homes in the process of foreclosure, banks are reporting the accrued interest as income even though it will not be collected.  Robert Lenzner has the story at Forbes:

All the phantom interest that is not actually collected is booked as income until the actual act of foreclosure. As a resullt, many bank financial statements actually look much better than they actually are. At foreclosure all the phantom income comes off the books of the banks.

This means that Bank of America, Citigroup, JP Morgan and Wells Fargo, among hundreds of other smaller institutions, can report interest due them, but not paid, on an estimated $1.4 trillion of face value mortgages on the 7 million homes that are in the process of being foreclosed.

Ultimately, these banks face a potential loss of $1 trillion on nonperforming loans, suggests Madeleine Schnapp, director of macro-economic research at Trim-Tabs, an economic consulting firm 24.5% owned by Goldman Sachs.

Mortgage servicers have come under increasing stress as their house of cards has collapsed.  Courts are now refusing to allow an easy escape from the sliced and diced securitization web that financiers have tied themselves in.  Up to 62 million homes have clouded titles, making foreclosures a dicey proposition.

Like Wile E. Coyote hovering off the cliff, the only thing preventing banks from falling into the abyss is the failure to account for their situation.

The fraudulent CEOs looted with impunity, were left in power, and were granted their fondest wish when Congress, at the behest of the Chamber of Commerce, Chairman Bernanke, and the bankers' trade associations, successfully extorted the professional Financial Accounting Standards Board (FASB) to turn the accounting rules into a farce. The FASB's new rules allowed the banks (and the Fed, which has taken over a trillion dollars in toxic mortgages as wholly inadequate collateral) to refuse to recognize hundreds of billions of dollars of losses. This accounting scam produces enormous fictional "income" and "capital" at the banks. The fictional income produces real bonuses to the CEOs that make them even wealthier. The fictional bank capital allows the regulators to evade their statutory duties under the Prompt Corrective Action (PCA) law to close the insolvent and failing banks.

Last year, financial firms were caught masking debt prior to quarterly public reports.

Three big banks—Bank of America Corp., Deutsche Bank AG and Citigroup Inc.—are among the most active at temporarily shedding debt just before reporting their finances to the public, a Wall Street Journal analysis shows.

...Over the past 10 quarters, the three banks have lowered their net borrowings in the "repurchase," or repo, market by an average of 41% at the ends of the quarters, compared with their average net repo borrowings for the entire quarter, according to an analysis of Federal Reserve data. Once a new quarter begins, they boost those levels.

...Intentionally masking debt to deceive investors violates Securities and Exchange Commission guidelines. Before sliding into bankruptcy in 2008, Lehman Brothers Holdings Inc. reduced its reported quarter-end borrowing by classifying repo loans as sales, a bankruptcy examiner found—creating what the examiner said was a "materially misleading" picture of Lehman's financial condition.

With nearly half of all mortgages estimated to be underwater, some properties have become so worthless that even the banks are walking away from them.

Without an economic incentive to foreclose, it would not be in the bank shareholders best interests to pursue foreclosure even though borrowers clearly defaulted & owe money to the lender. The economics of distressed assets in mortgage and commercial banking are quickly changing.

Originally posted to The Anomaly on Wed Jan 26, 2011 at 08:55 AM PST.

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Comment Preferences

  •  Tip Jar (31+ / 0-)

    Hope. It is the quintessential human delusion, simultaneously the source of your greatest strength, and your greatest weakness.

    by The Anomaly on Wed Jan 26, 2011 at 08:55:34 AM PST

  •  Is there a reserve/allowance (4+ / 0-)
    Recommended by:
    Jbearlaw, Lujane, nextstep, jfromga

    for writeoffs on the financial statements?  One would think this to be an obvious point, but there is much shitty journalism out there.

    "[R]ather high-minded, if not a bit self-referential"--The Washington Post.

    by Geekesque on Wed Jan 26, 2011 at 08:59:34 AM PST

    •  You expect journalists to know Accounting 101? (1+ / 0-)
      Recommended by:
      Geekesque

      I wonder how many of them can even balance their own checkbooks let alone understand GAAP.

      My Karma just ran over your Dogma

      by FoundingFatherDAR on Wed Jan 26, 2011 at 10:06:25 AM PST

      [ Parent ]

      •  bank accounting is so (2+ / 0-)
        Recommended by:
        ybruti, millwood

        accounting is so down the rabbit hole, who the hell nows what is what anymore.

        According to bank accounting logic.  I can declare Im worth 100 million, because see, last night I bought a lottery ticket, which could be worth 100 million, until that lottery happens, Im worth 100 million.  Of course if I lose, Ill just buy another ticket and keep that huge lie of worth alive.

        Bad is never good until worse happens

        by dark daze on Wed Jan 26, 2011 at 10:27:12 AM PST

        [ Parent ]

      •  JPM's Bear unit sued for cheating clients, (0+ / 0-)

        as reported by a financial journalist:

        According to the lawsuit, the Bear traders would sell toxic mortgage securities to investors and then sell back the bad loans with early payment defaults to the banks that originated them at a discount. The traders would pocket the refund, and would not pass it on to the mortgage trust, which was where it should have gone to be distributed to the investors who owned the bonds. The Marano-led traders also cut the time allowed for early payment defaults, without telling the bond investors. That way, Bear could quickly securitize defective loans, without leaving enough time for investors to do their own due diligence after the bonds were sold and put-back any bad loans to Bear.

        ...In 2007, when Ambac started to realize something was very wrong with its high-rated bonds, it demanded Bear provide loan-level detail and reviewed 695 non-performing loans in its portfolio. Ambac's audit concluded that 80 percent of the loans showed an early payment default. This meant they should have never have been packed in the bonds Bear sold and were required to be repurchased. Bear refused, and of course had already been pocketing buyback money for itself from the originators.

        Do you expect to muddy the fraudulent financial waters with snarky comments?

        Hope. It is the quintessential human delusion, simultaneously the source of your greatest strength, and your greatest weakness.

        by The Anomaly on Wed Jan 26, 2011 at 11:46:37 AM PST

        [ Parent ]

    •  yes, (2+ / 0-)
      Recommended by:
      Geekesque, dark daze

      They have to increase capital reserves each time a loan goes into the non-performing category (ie, payments have ended).  Which is why there is some extend and pretend behavior where the borrower continues to pay interest so the loan isn't technically non-performing, but the Reserves rules are tightening and in many audit situations at the banks, loan officers are being told to put loans onto fully amortizing basis or foreclose.

        Its ugly in the banking/commercial borrower community right now around here.  Smaller banks haven't gotten the Fed money the big banks got, and the loan market has dried up for smaller investors regardless of their credit history and the cash flow of their investments. Rates for many quality borrowers are doubling if they can get the money at all.  Frequently a property that was cash flowing at 4 percent doesn't cash flow at 6 1/2%, putting even more loans in default.  People with lots of equity are ok, but their net income has been greatly reduced.

      The super rich with cash reserves are making a killing.

      •  Citigroup was found to have an 80% defect rate (1+ / 0-)
        Recommended by:
        jfromga

        on loans sold in 2007.  

        Last April, a former top underwriter in Citigroup's consumer lending division, Richard Bowen, testified before the Financial Crisis Inquiry Commission about the mortgages that Citigroup had been buying from third parties and selling to Freddie Mac, Fannie Mae and other investors before its 2008 taxpayer rescue. Bowen said he discovered in mid-2006 that more than 60 percent of the mortgages purchased and resold by Citigroup were defective. By 2007, he said, that rate had increased to more than 80 percent.

        Do they have enough reserves to cover mortgage putbacks?

        Hope. It is the quintessential human delusion, simultaneously the source of your greatest strength, and your greatest weakness.

        by The Anomaly on Wed Jan 26, 2011 at 11:36:05 AM PST

        [ Parent ]

        •  we'll be seeing (0+ / 0-)

          what happens, the non-performing loans are different than the 'defective' loans.

          The vast majority of defects are minor and curable (or even irrelevant) from the point of view of collecting against a borrower.  A loan closing package can have two dozen documents, an error on any of them can be a 'defect', but few affect enforceability, in many cases if assignments weren't done timely, they can be done later and be legally effective, you just can't foreclose until you do the corrective work.

          The investors, based on their contracts, have rights to certain things that aren't based in the state property law that determines enforceability of the note/mortgage, and that presents a larger problem.  If there were deadlines set for all paperwork to be done or turned over to the investor, even though it can be done later, as a matter of contract law, the bank may be out of luck because it missed the deadline.  Until individual contract terms are litigated, no one can know what the losses are likely to look like.  'Substantial complaince' rules in some circumstances may save the banks, some states may have strict compliance standards, etc. and the banks lose. In the same contract, some terms may be subject to strict compliance, others may not.  In terms of damages, many times you don't get 100% damages, you get what you lose, if the bank can collect on the loan, there may be no loss.  If there is one of the 'put back' clauses that have been talked about where the bank has to rebuy the security, it may still not be a total loss, they may get a credit for amounts paid out in income if they do buyback, I haven't seen the language of any of the putbacks, and the courts may deem it a windfall to let the security holder to claim the purchase price and keep its earnings too, and the bank even if it has to buy back the security, may still be able to collect on the loan and offset that income against the loss.

          BOA was sued by a group of investors Monday, we'll see how that goes and what kinds of losses are possible.  The big guns are also settling as they can with Freddie and Fannie, investors in lots of that paper, and the first of the settlements was pretty favorable to the banks.  The private or sovereign wealth fund investors may not be as easy to deal with.  

          But those losses are outside your typical loan reserve losses for a non-performing loan.   That's one reason the banks have soaked up a lot of cash from fed but haven't been lending.   Rainy day money.

  •  Also, banks only recognize income accrued while (5+ / 0-)
    Recommended by:
    Jbearlaw, Lujane, nextstep, Benintn, New Minas

    <90 days past due.  Once it goes>90 days past due, they can't/don't report the income, as the loan is then considered non-accruing.

    "[R]ather high-minded, if not a bit self-referential"--The Washington Post.

    by Geekesque on Wed Jan 26, 2011 at 09:03:47 AM PST

  •  Wonder when/if (3+ / 0-)
    Recommended by:
    Jbearlaw, nathguy, Lujane

    we will ever admit we have zombie banks, and huge ones, just like the Japanese did.

    I must be dreaming...

    by murphy on Wed Jan 26, 2011 at 09:16:43 AM PST

  •  It's from the faith-based accounting community. (6+ / 0-)

    Why are your discriminating against people of faith?

    /snark

    Stop clapping. Stop screaming. Open your mind. Listen.

    by Benintn on Wed Jan 26, 2011 at 09:20:49 AM PST

  •  Tags appear to have too many commas (0+ / 0-)

    if you mean two-word terms like "phantom income" and "delinquent mortgages" or "abandoned homes", the comma between the words should be removed.

    My Karma just ran over your Dogma

    by FoundingFatherDAR on Wed Jan 26, 2011 at 10:09:16 AM PST

  •  all they have left (2+ / 0-)
    Recommended by:
    nathguy, bleedingheartliberal218

    all they have left is accounting tricks.

    Bad is never good until worse happens

    by dark daze on Wed Jan 26, 2011 at 10:23:18 AM PST

  •  Does anyone realize... (0+ / 0-)

    that despite these accruals, they reserve the amount they expect to be written off on the total value of the loan including interest in another part of their balance sheet and income statement...

    Obama - Change I still believe in

    by dvogel001 on Wed Jan 26, 2011 at 10:46:51 AM PST

    •  With 91% of loans misrepresented (1+ / 0-)
      Recommended by:
      Tonedevil

      at Bank of America's Countrywide unit, the amount of reserves may not be adequate.

      MBIA alleges that Countrywide, which Bank of America acquired in 2008, misrepresented the quality of loans in mortgage-backed securities to induce MBIA to insure against losses from defaults and foreclosures. Countrywide knowingly loaned to borrowers who couldn’t afford payments or committed fraud in their applications, according to the complaint.

      ...MBIA said its reviews found that 91 percent of defaulted or delinquent loans had "material discrepancies from underwriting guidelines," such as borrower incomes, credit scores or debt- to-income ratios. The 15 securities pools in the lawsuit consist of 368,000 home-equity lines of credit and second-lien loans that were insured and sold to investors from 2004 to 2007.

      Hope. It is the quintessential human delusion, simultaneously the source of your greatest strength, and your greatest weakness.

      by The Anomaly on Wed Jan 26, 2011 at 11:28:41 AM PST

      [ Parent ]

      •  That is a big "May Be"...n/t (0+ / 0-)

        Obama - Change I still believe in

        by dvogel001 on Wed Jan 26, 2011 at 12:13:51 PM PST

        [ Parent ]

        •  FDIC chair blasts banks for 'inadequate reserves' (0+ / 0-)

          as noted in Fortune:

          Bair warned that bankers may be reducing their loan loss reserves too early. Provisions for loan losses dropped to their lowest level in three years, even as "troubled loans remain near historic high levels," Bair said.

          Accordingly, reserves against future losses dropped to 63.9% of noncurrent loans from 65% in the second quarter -- too close for comfort as far as the FDIC chief is concerned.

          "Many institutions came into the recent crisis with inadequate reserve levels and they need to exercise restraint in drawing them down now," Bair said. "At this point to the credit cycle it is too early for institutions to draw down reserves without strong evidence of sustainable improving loan performance and reduced loss rates."

          Hope. It is the quintessential human delusion, simultaneously the source of your greatest strength, and your greatest weakness.

          by The Anomaly on Wed Jan 26, 2011 at 05:52:01 PM PST

          [ Parent ]

          •  And they can raise them as well... (1+ / 0-)
            Recommended by:
            soros

            if the regulators really had an issue with reserves or the SEC or the Auditors...they would make them re-state financials which they all have the power to do...otherwise it is a lot of CT hot air...

            Obama - Change I still believe in

            by dvogel001 on Wed Jan 26, 2011 at 06:00:43 PM PST

            [ Parent ]

            •  ... and out comes the 'CT' card (1+ / 0-)
              Recommended by:
              Tonedevil

              I must have struck a nerve...

              Hope. It is the quintessential human delusion, simultaneously the source of your greatest strength, and your greatest weakness.

              by The Anomaly on Wed Jan 26, 2011 at 08:03:58 PM PST

              [ Parent ]

              •  The CT folks on the accounting... (0+ / 0-)

                and banks is rampant here with BS and his mignons...there are no less than 4 auditors looking at these numbers and if you think that they are not accurate after all that scrutiny then you are a Conspiracy Theorist...

                Obama - Change I still believe in

                by dvogel001 on Thu Jan 27, 2011 at 02:14:08 AM PST

                [ Parent ]

                •  Are these auditors doing as thorough (0+ / 0-)

                  a job as all the 'folks' who approved $276 billion in liar's loans?

                  Hope. It is the quintessential human delusion, simultaneously the source of your greatest strength, and your greatest weakness.

                  by The Anomaly on Thu Jan 27, 2011 at 09:45:59 AM PST

                  [ Parent ]

                  •  Actually there is nothing wrong with liar's... (0+ / 0-)

                    loans if they have enough collatoral and assets to cover the mortgage...

                    For instance if you take out a loan for $150K on a house appraised for $300K and have $100K in liquid assets in the bank...who cares what your income is...there is no way they will lose any money on the loan...

                    Obama - Change I still believe in

                    by dvogel001 on Thu Jan 27, 2011 at 08:23:31 PM PST

                    [ Parent ]

                    •  How do you know the borrower has $100k (0+ / 0-)

                      if they don't provide any documentation?

                      Hope. It is the quintessential human delusion, simultaneously the source of your greatest strength, and your greatest weakness.

                      by The Anomaly on Thu Jan 27, 2011 at 10:35:01 PM PST

                      [ Parent ]

                      •  Usually these loans are given... (0+ / 0-)

                        from banks where the borrowers already have substantial assets in them and the only liar's part is the income not the assets...assets are verified (bank/investment accounts)...

                        For instance, I have all my accounts at Bank of America so they can directly verify the balances in my bank/investment accounts and see that deposits were made into my business account...regardless of my actual income...

                        Obama - Change I still believe in

                        by dvogel001 on Fri Jan 28, 2011 at 09:16:52 AM PST

                        [ Parent ]

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