Smoke & mirrors (continued)

Reuters financial blogger Felix Salmon discusses the continuing distress in the mortgage market. The chart he includes shows that foreclosures and mortgages in distress are still climbing, belying the talk about economic recovery. Thus far, loan modifications are not working because they still leave homeowners underwater. The only thing that will help is reduction of mortgage principle but banks won’t go there. The reason Salmon says, and as I indicated in my previous post, is that banks don’t dare acknowledge that the value of the mortgages they hold aren’t worth anything close to what they say they are.

Why are the banks behaving like this? I think the obvious answer is the right one: they’re holding these loans on their books at much more than they’re really worth, and they can’t afford to take the write-downs which would accompany principal reductions of roughly the same magnitude as the decline in housing prices. This kind of head-in-the-sand behavior can only possibly work if housing prices suddenly rebound in the next couple of years, and that ain’t gonna happen.