Lenders and Mark to Market

My business partner, Ron, just tried to refi his home with Wells Fargo after they enticed him with a very attractive interest rate. After some initial discussion he came into my office and said, "You know what they told me?"

Here's the story: Wells Fargo said that they'd give him the attractive rate and very low refi costs, but that his property had lost 30% of its value. It was built a year ago and the subdivision is brand new. Pittsburgh, by the way, had no real estate bubble and values are reported as perhaps the most steady in the nation even today.

Ron was livid. They told him there are no comparables in his neighborhood so they just wrote it down 30%. But it's a brand new neighborhood. There wouldn't be any comparables. Apparently Wells Fargo doesn't do live appraisals or even look to tax appraisals for guidance, either.

I saw something strange in this whole turn of events and I suggested to Ron that this could be a way for a lender to reduce the total liability on their balance sheet. Eliminating mark to market would allow them to adjust their balance sheets the way manufacturers can select LIFO or FIFO to more accurately reflect their costs given changes in demand and fluctuations in material costs. But, Congress won't let lenders do that because Congress' agenda isn't advanced by really fixing the housing crisis - only by looking like they're trying.

So, this is a clever, legal workaround. If lenders can entice borrowers to agree to give up their equity, turn back the clock and take real losses instead of forcing them to appear as paper losses on the lenders' books, then they can show an improvement. Problem is, that devalues all real estate and especially the real estate market. It also creates a time bomb for the borrower who agrees.

In five or so years, if you decide to sell your property, the devaluation provides you no equity margin, no downpayment in equity, and probably a debt greater than the value of the property. Your solution will likely be to roll that old debt into a new home mortgage that straps you to a higher interest rate. Inflation, higher interest rates, lower real estate values. Hmmmmm.

It's a perfect example of how bad regulations case more problems than they solve. They always do.