How Big Is the Foreclosure Mess?

The size of the foreclosure morass is a crucial question. The moratoriums are hitting the real estate markets like a tractor trailer. Bank losses are inevitable. If the crisis is large enough, it could present systemic risk. Federal regulators and the rest of us need to know pronto if the banking system is going have a fainting spell just because some pennywise and pound foolish bankers thought it would be a good idea to disregard formal legal procedures for making mortgage loans, securitizing them and then foreclosing on them. Probably hundreds of thousands of foreclosures have now ground to a halt, and possibly hundreds of thousands more will be brought into question (including many foreclosures already done). Questions over ownership of mortgages and flaws in foreclosure procedures present the potential for another body blow to the banking system. Even though some of the foreclosure problems have been known for many months or even longer than a year, federal banking regulators have missed the boat again in not seeing this hot tamale right in their laps. Oh well, America will always have taxpayers, so there's a ready herd of sheep to be sacrificed if the bankers don't want to bear the losses themselves.

One potentially useful way to get a sense for the magnitude of the monster would be to read the 3rd quarter financial reports that the major banks will be filing soon. The foreclosure crisis couldn't have blown up at a worse time for them. The third quarter ended for most banks on September 30, 2010. The publicly traded ones have to file a public quarterly report by November 14, 2010. Those filings would include disclosure about the foreclosure mess, and the financial information reported would have to reflect costs and losses from the crisis (such as reserves to cover potential liabilities and writeoffs). Banks that understate the extent of the problems may find themselves sued by regulators and shareholders, so they have strong reasons to be forthright. At the same time, if the foreclosure problems are really big, being forthright might make their creditors a little weak at the knees. Memories of firms with names like Bear, Stearns and Lehman would stir. Bank creditors might be overheard muttering something about the devil taking the hindmost.

Five weeks remain until the banks must file their 3rd quarter reports. That's not much time to get a handle on the situation. They have to figure out the actual and potential losses from their own mortgage holdings, and also the extent of the blowback from mortgages they thought they sold, and securitizations they underwrote or are servicing. Because many banks issue quarterly financial results in press releases within two or three weeks after the end of the quarter, they actually have much less time than the formal filing deadline gives them. The numbers and information in those press releases must also accurately reflect the impact and ramifications of the mess. The heat is on. We may know more very soon.