From a letter Barney Frank wrote to the major banks about the 2nd mortgages they carry on their books at full value (in spite of the 1st mortgage being underwater):
http://www.zerohedge.com/article/barney-frank-asks-top-four-banks-write-down-second-lien-mortgages-claims-have-no-economic-vaMany 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.
and this analysis says the stress tests prove the biggest banks are actually insolvent (more charts and all at link):
http://www.newdeal20.org/?p=8835So the original loss from second-liens, as reported by the stress tests, was $68.4 billion for the four largest banks. If you look at those numbers again, and assume a loss of 40% to 60%, numbers that are not absurd by any means, you suddenly are talking a loss of between $190 billion and $285 billion. Which means if the stress tests were done with terrible 2nd lien performance in mind, there would have been an extra $150 billion dollar hole in the balance sheet of the four largest banks.
Major action would have been taken against the four largest banks if this was the case.Tradeoffs
Notice the tradeoff – with this valuation of 2nd liens locked into the stress test, it meant that a huge chunk of homeowners wouldn’t be able to renegotiate their mortgages. So you have a decade of people underwater in their homes, unable to move to pursue new jobs, with the 1st mortgage owner willing to negotiate new terms but being blocked by the second mortgage owner, in order to pretend that the stress tests weren’t completely invalid.And the endgame? I’ve heard anecdotally from enough credible people that there’s extra pressure on underwater homeowners to pay off the small second lien first. This is in part because the servicers, who will be nudging (or “sweat boxing”) homeowners in desperate situations on how to act, work for the major banks, and in part because the second liens are usually smaller and easier to pay. This is what happens when servicers don’t have a fiduciary responsibility to investors. Between that and playing the gruesome (for regular people) spread on interest rates, the major players should be able to drag themselves to solvency.
All bolding added by me for emphasis on the fact that the biggest banks in the country are still carrying phony numbers on the books because they're insolvent without them.
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