Banks have been extremely adverse to doing this, because accounting rules allow them to postpone writing down the value of second/junior loans on real estate. If the first loan is underwater, then the second is nearly or likely worthless. But if banks can postpone the hit to equity capital, they can continue to borrow at zero and lend at more than zero.
From the letter:
"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."
Below is the snapshot from wlmlab of the at-risk junior liens on these four banks books.
The following is the amount of tangible equity value that would be wiped out if junior liens were written down to zero.
BAC = 18%
JPM = 12.6%
C = 22%
WFC = 19%
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