No, not California, but everywhere that housing prices are falling. This article points out that banks buy their own foreclosed houses for what they’re owed, then carry them on the books at at least that value, if not a bit more. Welcome to the land of toxic assets.
A good local example of this is the recent foreclosure auction on Round Hill Road (414? I forget – the land and tear-down behind Round Hill Community Church, once owned by Robert Weiss). Seven indivisible acres with a house riddled with mold, the bank was owed $3.9 million and I believe that’s what they bid. I don’t think the land is worth anything like that – very nice property, but in this market, if I were a guessing man, I’d say somewhere between $2.7 and $3.3 ought to take it. If I’m right, there’s as asset on that bank’s books that’s being carried for at least $700,000 more than it’s worth. If I’m right. Here’s a portion of the article I link to – don’t miss the paragraph, “Dislocation Ideology” – it sums up what’s happening here, in my opinion.
Dropping Prices Mean Hidden Losses Mount. The bank’s purchase of the house may have put a floor on the immediate losses from the mortgage default but it doesn’t stop housing prices from dropping. If the housing market continues to deteriorate, the house now owned by the bank could be worth even less. The bank bought the house for $175K and booked it at $190K. But the market value of the house could be far less. If the value of the house drops to $150K, the bank is sitting on unrealized losses of 25% but has only booked a 5% loss.
How To Invent A Toxic Asset. Let’s conclude with the idea that this is exactly how a toxic asset is created. A bank buys something and books it at a value that winds up being far higher than the market value. It can’t sell the asset without realizing horrific losses. Investors and creditors of the bank know that it is holding these things at far above their real value, however, and discount the credit worthiness and profitability of the bank accordingly.
Dislocation Ideology. All of this is made possible by one thing: an ideological conviction that the national housing slump should have been impossible and therefore that housing prices are sure to recover shortly. That’s what we call the “Dislocation Ideology”–the idea that housing markets are temporarily dislocated and will soon find themselves back on the old path onward and upward.
If a long term downturn were acknowledged, a conservative bank would avoid buying foreclosed houses and prefer to take the losses up-front, letting the outside buyers pick up the home and the downside risk of further price slides. But banks are still long housing, so they keep buying houses and booking them at inflated values.