Mark to Market, a Painful pill for Banks.

In a letter to the CEOs of Bank of America, Wells Fargo, JP Morgan Chase and Citigroup, House Financial Services Committee Chairman Barney Frank asks that the banks admit losses on all the valueless second mortgages that they hold. By doing so the banks would basically be showing how close to insolvency they actually are. But I have to wonder if Franks request are a hint toward things to come. I suspect he knows they will not do this willingly.

This makes me wonder if he gearing up for a reinstatement of mark to market. Mark to market rules would force the banks to value real estate holdings at current market value as was the case about a year ago (At that time they removed the mark to market requirement in the FASB accounting rules to stop the banks from showing how much trouble they were really in).

Currently, as I can best understand it, the banks are able to mark to the value of the current loans against the properties. So if you owe the bank 300k but the current market value is 150k, then currently the bank can show they have an asset worth $300k whereas if mark to market were reinstated then they would have to revalue that asset at $150k.

This rule change about a year ago as well as other factors are what I believe helped fuel the rally from March '09 until now.

Mr. Franks wording in his letter is pointing toward an attitude that the banks need to get back to a reality based accounting standard. If the banks choose to follow the recommendations in the letter, or if they are forced to do so via reinstatement of mark to market rules, either way bank stocks are likely to head for trouble. Keep your ears peeled. If reinstatement ever happens then the banks may lead the market into a new round of pain.


HERE IS THE FULL LETTER:


Mr. Brian Moynihan
Bank of America

Mr. Vikram Pandit
Citigroup

Mr. James Dimon
JP Morgan Chase

Mr. John Stumpf
Wells Fargo


Dear Messrs. Moynihan, Pandit, Dimon and Stumpf:

The mortgage foreclosure crisis that began over two years ago, and which continues to be a prime contributor to our nation's current economic downturn, burdens millions of hard-working American families. Congress and the Obama Administration have worked hard to address foreclosures by enabling and encouraging loan modification s, but the private sector's response has fallen far short of the need. Many homeowners are eager to save their homes despite being "underwater," but find that lenders and servicers are unable or unwilling to make necessary modi fications. These homeowners are increasingly deciding to walk away and thus foreclosures continue to mount, deepening the crisis.

To save homes on a large scale, we must move past temporary modifications in interest rates or terms and focus on permanent principal reductions that result in truly sustainable mortgages. There is no more important priority for me in our efforts to restore stability to our mortgage market.

Many investors in first-lien mortgages have indicated that they are willing to accept the fact of significant losses on those investments in order to move on and use their money for other purposes, rather than having it locked in underwater mortgages with a high and growing likelihood of foreclosure. With the interests of homeowners and investors aligned in this way, it should follow that large numbers of principal-reduction modifications could be made relatively quickly. That is not happening. According to investors, Administration officials, and other experts I have consulted, holders of second-lien mortgages are now a principal obstacle to many modifications. The problem of second-lien mortgages standing in the way of successful principal reduction modifications has reached a critical stage and requires immediate
attention from your institutions.

Large numbers of these second liens have no real economic value - the first liens are well underwater, and the prospect for any real return on the seconds is negligible. Yet because accounting rules allow holders of these seconds to carry the loans at artificially high values, many refuse to acknowledge the losses and write down the loans, which would allow willing first lien holders to reduce principal and keep
borrowers in their homes.

The four organizations you lead are major participants in the second-lien market. Failure to modify these debts has become a major and unnecessary obstacle to thousands of Americans being able to stay in their homes. I urge you in the strongest possible terms to take immediate steps to write down these second mortgages and allow principal reduction modifications of the underlying first liens to take place. If there are legal obstacles to your doing so, we will work with you to remove them.

I will be calling you within the week to discuss what your institutions plan to do to remove the second liens you own or control as impediments to principal reduction modifications.