Subprime solution

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Five banks involved in the foreclosure fraud scandal of 2010 say they have made significant steps toward satisfying a $26 billion settlement.

A report by Joseph Smith, an independent monitor keeping track of how banks are complying with the settlement, said banks have made the bulk of their settlement compliance so far through short sales, which is a sale in which the bank allows the homeowner to sell property for less than what is owed on the mortgage.

That would be a loss for the bank, if only a paper loss -- a loss on returns the bank might have received over a period of time, which may have been up to 30 years.

Given the short sale fails to cover a paper loss, banks involved in the settlement are only able to claim a portion of the short sales against the $26 billion settlement. On short sales, the banks can claim 40 cents on the dollar, The New York Times reported Thursday.

Despite the diluted benefit, banks are leaning on short sales because that is a long-established system. From a political point of view, however, it sounds better if the intervention allows homeowners to stay in their homes. Politicians can't say they supported the America dream of home ownership by forcing banks through a settlement to write off losses incurred when homeowners give up on their mortgages.

From day one of the financial meltdown -- and since, presumably, the dawn of time -- what the banks have been reluctant to do is to reduce principal owned on a loan. That just hurts too much and it goes against the grain. No bank wants to hand out $100,000 -- not as a paper loss, but real money -- and have to accept lower payments on what is owed on that.

Banks want the whole enchilada -- the principal and the accrued interest. Reluctantly, they will take a loss if the loan fails, but preferably in a cut and dried fashion. Like ripping off a band aid, banks first want to leave that band aid on forever and secondly they would like it pulled off quickly if it has to go.

The five banks, Ally Financial, Bank of America, Citigroup, JPMorgan Chase and Wells Fargo, have each handled their end of the settlement their own way. Bank of America, for example, has a score of zero, so far, when it comes to principal reduction. The other banks in total have dropped $750 million off of the principal side of the loans that have been modified.

U.S. Secretary of Housing and Urban Development Shaun Donovan said the settlement provided for "the most significant principal reduction that we've seen since the housing crisis began."

This highlights the misguided nature of the silver bullet political solution of seeking out principal reduction for the past five years.

That creates the headline politicians are after: "Homeowners rescued from fate of going homeless," but it also meant that, while clinging to the idealized goal of home ownership -- in the midst of a subprime mortgage market collapse, no less -- problems in housing dragged on because banks didn't like the solution offered (reduce principal) and politicians didn't understand the banks' reluctance to write off the real money they had loaned.

If there is any gain to all this, the housing market, given the stumbling efforts to fix it, has had to turn itself around on its own organic terms.

RealtyTrac reported this week that second quarter home sales that included a home involved in some stage of foreclosure came to 224,429, down 12 percent from the first quarter and down 22 percent from the second quarter of 2012.

Despite the drop, the percentage of home sales that involve a repossessed home or a home involved in foreclosure has risen to 23 percent, up from 22 percent in the first quarter and 19 percent from the second quarter of 2011.

In international markets Thursday, the Nikkei 225 index in Japan gave up 0.95 percent, while the Shanghai composite index in China was flat, off 0.03 percent. The Hang Seng index in Hong Kong dropped 1.19 percent, while the Sensex in India rose 0.29 percent.

The S&P/ASX 200 in Australia lost 0.93 percent.

In midday trading in Europe, the FTSE 100 index in Britain shed 0.22 percent, while the DAX 30 in Germany slipped 0.85 percent. The CAC 40 in France dropped 0.47 percent, while the Stoxx Europe 600 gave up 0.39 percent.