Banks Again Depress US Economy

There is a basic lesson about capitalist (in)efficiency in this sad story.



by Rick Wolff

Banks are once again depressing the broader US economy. Its all collateral damage as they take care of their own business, making money and shoring up their balance sheets. This time the issue for them is how profitably to dispose of their accumulated homes acquired when they foreclosed on delinquent mortgages. They are selling those houses very cheaply, discounted well below prices for comparable properties, thereby depressing the housing prices for everyone across the nation. According to RealtyTrac, the online marketer of foreclosed properties, foreclosures
accounted for 28% of all existing home sales in the first quarter of 2011. This weakens the so-called “recovery” and helps explain why the US housing market has already turned down again.

Here is the economic problem. When banks take homes because the owners cannot pay back the money borrowed to buy the homes, the banks have a problem. First, they now own an asset whose price is falling in most markets. Second, owning a home incurs expenses (maintenance, insurance, property taxes) the bank will need to pay. Third, banks make money by lending at interest, not by owning real estate; they must convert foreclosed homes into cash they can then lend.

Under the law, when a lender forecloses on a home owner, the lender can sell the home. The lender takes the proceeds up to the amount owed on that home. The lender must return to the foreclosed homeowner whatever portion of those proceeds exceeds what was owed to the bank. This creates a perverse incentive with bad social consequences.

To see the problem, suppose a bank has foreclosed on a home worth, say, $200,000 in today’s real estate market, that carries an outstanding mortgage balance of $150,000. If the bank puts the home on the market for $200,000, it may take months of waiting for the house to sell (incurring expenses for the bank). The bank can instead decide to speed the sale by offering the house at a discount from its actual market value, say, $175,000. At that price, the bank can still pay itself back the outstanding $150,000 owed on the house. It is the foreclosed homeowner who loses out by getting only $25,000 instead of the $50,000 if the home had sold for the full $ 200,000. It is also the broad housing market whose prices drop generally because of banks selling foreclosed properties at discounted cheaper prices.

According to RealtyTrac, the average US price charged on foreclosed homes when they are sold is 35% less than the price of a comparable, non-foreclosed home. In some states it is much higher: 53% in New York and 50% in Illinois, Ohio and Wisconsin.

The key point here is that normal, profit-maximizing business for the banks is once again bad for the larger economy. Before 2008, banks' profit-driven speculations in asset-backed securities, credit default swaps, etc. provoked the great crash and crisis of that year. Afterwards, bailout money poured by the government into banks was kept to help the banks recover rather than lent to US businesses and individuals to help them recover. Now, banks are taking care of their mortgage foreclosure business in a way that again damages the larger economy as they pursue their self-interest. Moreover, Realty-Trac estimates that it will take three years to sell off the inventory of foreclosed homes. That promises a long downward pressure on the US economy directly undercutting hopes for a broad-based recovery.

There is a basic lesson about capitalist (in)efficiency in this sad story. How convenient for the status quo that so few voices raise the obvious question: should we allow national economy recovery to be sabotaged in these ways?

from Rick Wolff's Blog