Why Banks Prefer to Foreclose

When the bank loaned you the money they had no intention of keeping those loans very long.  In fact, if you borrowed the money from one of the larger banks (Countrywide, Wells Fargo etc), they had buyers for those loans through the complicated securitization process set up by Wall Street.

If you have the opportunity to watch CNBC's special, "House of Cards," I would recommend you watch this. 

Do you remember "Mortgage Insurance? (MI)"  It was an insurance policy that you paid for to protect the lender from a loss in the event you didn't make the payment.  During the "boom" times, MI pretty much went away as we knew it.  If you think of insurance as money paid to the insurance company that "bets" they won't have to pay on the policy.  The price of the premium is based on risk so the riskier the bet, the higher the premium.  Insurance is regulated as the government feels (rightfully so) that insurance companies need to maintain adequate levels of capital to pay out claims.  Insurance is also regulated to make sure premiums are not unnecessarily high  It's a balancing act which allows coverage to policy holders, reasonable profitability of insurance companies along with adequate capital to pay claims. 

Enter the Wall Street Creation of Credit Default Swaps (CDS).  It's a way to "bet" something is going to happen.  Making a "bet" that loans would go bad during the boom was an almost certain fools bet.  Prices were going up, money was everywhere so the "insurance" aspect was probably quite cheap at the time.  The focus was not on the individual mortgage or loan but was on the pool your loan was placed in.  Had they called it "insurance" it have most likely been scrutinized AS insurance by regulators.  Since the loans were securitized, CDS were bought to insure the loans as a block or security.  It served the same function as mortgage insurance for the lenders and investors but without all that nasty regulation.

60 minutes ran a story in October of 2007 just about Credit Default Swaps which goes into greater detail.  Click here to see!

Having read a couple of these pooling agreements, they state that if the lender negotiates with the seller, the orignial lender MUST buy the loan from the pool at face value.  There is a big incentive the lender NOT to settle.  Additionally, if there is to be any CDS money paid out, the loan must be defaulted and/or foreclosed.

Assuming a CDS paid or covered the same amount as MI, that would be about 20-30% of the original loan amount.  We'll go with 25% for argument's sake.

Using information from the actual case when the light started to go off as to why short sales generally do not work.  The original loan amount was $180,000.  The offer comes in at $105,000.  The Broker Price Opinion / Appraisal comes in at $100,000.  Bank states NOT to send any offers in for less than $130,000 (It took them 3 months to come back with this).  Does this makes sense????  YES, to the bank it does.  Here is why.  The appraisal value is $100,000.  The CDS pays 25% of the original loan or $45,000.  The banks knows it will sell for less in the future (assume $15,000 less) and guess what that net number is to the bank, the same $130,000 they stated was their minimum price.  Of course this would NEVER happen because the appraisal is not there.  See case 1, case 2, case 3 for more information.

From our research, we found the a comment that the London arm of AIG International was the biggest issuer of Credit Default Swaps.  Where do you thing the government bail out money went to?  The holders of CDS's, banks etc.