The Undisclosed Inventory of Homes

My comment on the article, Foreclosure Machines Still Running on ‘Low’  By Robbie Whelan in The Wall Street Journal [Developments Blog] – pub. July 31, 2012 at: http://blogs.wsj.com/developments/2012/07/31/foreclosure-machines-still-running-on-low/?blog_id=36&post_id=21215

The shadow inventory and the large inventory of bank ‘Real Estate Owned’ (REO’s) is a phenomenon which I believe has been caused to a significant extent by the decision to delay the implementation of FAS #157 [commonly known as ‘fair value accounting’ or ‘mark-to-market accounting’].

The delay in the implementation of mark-to-market accounting allows mortgage investors to report (on books and records) the value of their mortgage investments at the investment’s origination value rather than requiring these assets be valued at an estimate of current market value. See article, Congress Helped Banks Defang Key Rule By Susan Pulliam & Tom McGinty - pub. Wall Street Journal June 3, 2009 | at: http://online.wsj.com/article_email/SB124396078596677535-lMyQjAxMTIyNDMzMTkzNjEwWj.html?mod=wsj_valettop_email

For further insight into the implications, and one of the likely consequences of the delay of mark-to-market accounting watch a brief video-clip of a portion of Georgetown University Law Professor, Adam Levitin's U.S. Congressional testimony titled, Federal Regulators Don't Want to Know at:

The shadow inventory and bank REO's (not under current listing contracts) represent an historically significant supply of housing which in many ways is not transparent or adequately disclosed, and therefore is not fully-factored into the ‘market's pricing” of homes (supply and demand).

Zombie Accounting and The Shadow Inventory

I recently watched a U.S. House of Representatives Judiciary Committee Hearing on C-SPAN. The hearing, which was held on December 15, 2010, was titled “Mortgage Services and Foreclosure Practices”.1 The testimony and the questions and answers in the hearing provided a significant amount of interesting information about the processes, and the legal and practical issues surrounding the mortgage servicing industry, and the Mortgage Electronic Registration System (MERS).

Because I followed the history of Congress’s involvement in pressuring the Financial Accounting Standards Board (FASB) to delay the implementation of FAS #157 in early 2009.2 I found a question, which was asked by Congressman Bobby Scott (D. VA) troubling.

At approximately 1 hour 36 minutes into the hearing Congressman Scott asked, in essence, if there was anything in “accounting standards” that might provide incentives for mortgage investors and mortgage servicers not to agree to short sales and to prefer alternatives that might be less advantageous for all parties.

I was surprised by the question because of Congress’ significant role in pressuring the FASB for a delay in FAS #157 and I was also bit surprised that none of the witnesses could directly answer the question - from an accounting standards perspective. In general, the witnesses only discussed the mis-alignment of incentives, where mortgage pooling and servicing agreements provide ongoing revenue for servicers when a short sale is not agreed to and a foreclosure is delayed.3

Footnotes: 
1. The December 15, 2010 House Judiciary Committee “Mortgage Services and Foreclosure Practices” hearing may be seen at:  http://www.c-spanvideo.org/program/297095-1
2. See a Wall Street Journal article titled, Congress Helped Banks Defang Key Rule By Susan Pulliam and Tom McGinty pub. 6/3/2009 at: http://online.wsj.com/article/SB124396078596677535.html Also see, For Your Reading Pleasure By Jack Ciesielski pub. in the Analyst’s Accounting Observer 2/25/2010 at: http://www.accountingobserver.com/PublicBlog/tabid/54/EntryId/12583/For-Your-Reading-Pleasure.aspx
3. Under the typical mortgage securitization “Pooling and Servicing Agreements” mortgage investors agree to pay mortgage servicers fees for arranging: home inspections, arranging broker ‘opinion of value’, preparing and filing documents, general documentation, notifications, forced insurance fees, and etc.