How Can You Benefit from a Lower of Cost or Market Mortgage Write Down

In many areas of investments and accounting when a company has an assets on the books and the market value of the asset drops below the original cost of that asset, the company must write down the value of the asset on their books.  Writing down that asset requires taking an expense which can result in a loss for the company involved.  Good accounting principles require this move as it does most companies and especially investors no good to keep a fictitious value on their books.  Plus, the recognition of the loss can enable the company to save a little on taxes, a small condolence for losing asset value.

Fed Chairman Bernanke is essentially calling for something similar to help solve the mortgage crisis.  He’s calling on Treasury Secretary Paulson of the Bush Administration to take action to push lenders to write down the value of the mortgages that you might hold.

Bernanke said “more can, and should, be done” to limit foreclosures. He added that principal reductions “may be a relatively more effective means of avoiding delinquency and foreclosure” than renegotiating interest rates. … “the current housing difficulties differ from those in the past, largely because of the pervasiveness of negative equity positions.”  Bloomberg.com: U.S.

For example, if you have a mortgage in San Francisco for $800,000 and the real value of your property is now $650,000.  People are not companies and do not keep a lower of cost or market basis in their homes.  Banks however, take those mortgages and sell them to investors in a process known as securitization.  Banks would have to decrease the value of the mortgages they hold before the sale to investors and possibly after as well.  Think of it like Wal-Mart providing you a credit on a receipt if the price of a TV goes on sale within 30 days of buying it at their store.  Banks would essentially, have to give investors a credit on their investment, take a loss and let mortgage holders off the hook for the loss in home value and readjust the monthly mortgage payment downward.

That is definitely a tough pill to swallow for banks, but they may have no option. If they do not make such an adjustments, a homeowner that holds a property worth $650,000 with a mortgage of $800,000 might quite logically make the investment decision themselves to walk away from the house and allow a foreclosure to happen.  Every day they stay in that over mortgaged house, they are essentially making the decision to over pay for their own house by $150k.  That’s a bad financial move for a home owner thinking like an investor.

This same process could unfreeze credit from investors too.  If they get a refund on their investment, they could conceivably invest in new mortgages at more appropriate values.  Investors need to see that foreclosures are stopping, that people are buying houses, that the real estate market correction is over and most importantly that banks can be trusted again!

The Fed, the Treasury Secretary, banks, investors and home owners are all essentially trying to find a way to put some baby clothes back on the baby after throwing the baby out with the bath water.  The downside to this proposal is that it essentially puts the blame and the cost on bankers.  Except in the cases where banks created or contributed to fraud, homeowners are the ones that made the initial bad investment decision of buying a house that subsequently later devalued.  The fraud of the banking industry does appear substantial, but buying into a bubble can not be ignored either.  This will definitely be a difficult concept to pass through Washington DC during an election year.

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