Elizabeth Warren weighed in today with her assessment of the reason for the slow pace of loan modifications as well as the banks’ purported reluctance to lend. In her opinion it’s a problem caused by accounting rules.
Business Week reports that Warren is of the opinion that accounting changes that permit banks to value their whole loans at historical cost as opposed to current market value causes them to adopt a strategy of holding the loans and hoping that they recover their value over time or that during the holding period they are able to earn their way out of their problems.
Accordingly, they are reluctant to modify loans as that would mean they would have to recognize losses and they are reluctant to lend because they know they are worse off than their books imply and, therefore turn to hoarding capital in anticipation of the day of reckoning. Warren implies that this problem is most acute among the smaller banks and that continues to place the system at risk and prolongs or at least stymies the recovery.
Warren proposed no solutions, saying that it was the job of her commission to point out problems not make policy. Sweet Job, that.
Permit me to offer a few observations that will more than border on dissent.
First, banks can’t just let loans sit on their books and pretend that they have no problems. Though they may not have to value them at a current market price, they do have to provide for reasonable loan loss provisions. That does have an impact on earnings and it’s a matter of conjecture as to whether that would be more or less than valuations based on market.
Second, so long as loans are being serviced their is a very plausible case to be made for minimal markdowns. On any given day the ultimate fate of a loan may look bleak or rosy but the actual outcome is going to be determined by economic events that are best seem through a blurred lens. Many a company or individual given the chance to work out their debts have done just that. Neither Warren nor any other government employee has the wherewithal to predict with any certainty whatsoever, the ultimate performance of a loan portfolio.
As to earning their way out of their problems, we should be so lucky. Even if the loans are poorly valued or reserved for, if the banks are not rushed to write them off (remember, many are performing) and do accumulate capital via retained earnings with which to eventually absorb the losses, what’s so bad about that?
Warren is using some peculiar logic to trumpet the need for modifications. As I have said numerous times, we are operating with incomplete information about the behavioral aspects of the mortgage market as it pertains to borrowers and lenders. The call is for loan modifications but those making the call don’t have a clue as to whether it will actually help with the problem, make it worse or perhaps turn it into a chronic condition that just sucks the blood out of the housing market for years to come.
Warren’s job is easy if you have no responsibility for proposing real policies to deal with the issues. You just paint the problem in black and white and are absolved of the nasty consequences that real solutions carry. Unfortunately, in the real world you not only have to identify the problem but devise a solution that won’t result in outcomes that unacceptable.
Warren is lobbing grenades without joining the battle.