In this, Part II, we'll look at why banks will foreclose instead of refinance: Here are some (again simplified) answers:

1) (Hinted to in Part I) Because most of these mortgages are bundled up and sold as assets and the investors all have to agree to refinance. If you want a more complicated answer on this: some mortgages are carved up into many pieces and the pieces themselves bundled with other mortgages and sold to investors, making it even more complex

2) Many of these 'mortgages' aren't just one: a homeowner may have gotten an initial mortgage and later a second from another source. Now the 2 sources (banks) have to work out what to do; another complex situation we won't get into here.  The vast majority of properties we sell for banks in in this situation with every one having a 2nd, the lowest 2nd we've seen was 25% of the value of the first and the average 50-100%. We've seen many that are more than 200% of the first and one that was 1.2M on a house with no mortgage at all.

3)  Many banks (see #2 above) are not interested in refinancing homes that are heading into foreclosure because of 2nd loans. There are many reasons. One of those it that some of these folks thought they could just refinance again and again even though they were approaching or already at their maximum ability to pay.  In short, they believed prices would just continue going up and they could sell their home to pay all the mortgage debt.  A bank can't recast a $500K loan to $250 (what the person can pay, for example). If the bank can sell the house for $325 instead, then they have a duty to their investors who actually own the mortgage.

4) Because on the subprime loans, if they refinance with the same borrower (who now has worse credit) that mortgage is worth essentially nothing.  Those mortgages need to have 'book' value so that they can be sold again to buyers and or so that the investors who own them now can show that their investment has value.

If an asset you own has little value (let's say you are thinking you're buying $1K worth of gold, you pay $1K and find out later that it's really only fools gold worth $20) then that's a huge problem. The same is true not only for the investors who own the mortgages, but for all the people in the chain who used that asset to make other loans, using it as collateral.  If a bank refinances that same asset that really had a value of onl $20, then it will likely have an even lower value, say of $10 and therefore cause even more damage to that bank's 'books' or the investor's books, ultimately lowering the entire value of the bank or investment company. On a large scale, this (in VERY simplified terms) is how banks and big investment firms go belly up.

In the 3rd of the series we'll talk about how what elements came together to cause this collapse.

We're often asked about the process by which banks foreclose, resell homes and why they can't simply refinance the mortgages.  Some (simplified) answers are below.

How long do foreclosures take? typically 6 months to a year

Why can't a bank just refinance the loan? Some banks 'keep' their own loans, that is, they don't sell them to others. These banks are able to refinance those loans.  Most loans (mortgages) however, are 'bundled' and resold to investors.  It is these investors who ultimately decide if a loan can be 'recast' or revised.

Who are the investors? It's complex, but you could be one! Let's say you own shares of, say, Great Investments Mutual Funds (made up) and one of the companies they have stock in purchased one of these bundles.  Then technically, you are an owner of one of these mortgage bundles.

Many of the biggest investors are overseas.

What about these big banks, like Chase, foreclosing on a lot of properties?: Chase Bank actually has only about 20% of its own loans.  But it is a big 'servicer' of other loans. This means that it, for a fee, collects the mortgage payments, among other duties, for whomever owns the mortgages.  Most servicers also have the responsibilty of the foreclosure/resale process, should it come to that, even though it's not one of their own loan per se.

Most of the big banks 'service' many loans that they didn't 'originate' (make to the borrower).

Why is this affecting our economy when a relatively small percentage of homes (estimated at less than 4%) are in foreclosure?

Because those bundled mortgages were also used as collateral (based on the value of the mortgages) in very big ways to get loans for other investements.  Let's say that some big investment firm called Big Bob bought a huge bundle of mortgages that they thought would net them, say 8%/annum. The cost of that investment, by the way, is very much related to the 'safety' (stability of the homeowners and value of the homes, essentially) of those mortgages.

Then that firm might say "we have this asset worth (let's say) 10M dollars and we are going to use that as collateral for a 5 million dollar loan from John Smith company.  John Smith is happy to give 50cents on the dollar and does so.

But because we were in a housing bubble (all bubbles break) the value of those homes drops and pretty soon, some folks can't refinance or sell because now their mortgage is more than their house is worth.

That means this big bundle isn't worth 10 million anymore.

Even that would be ok, but let's say now some of those homeowners in the bundle can't pay their mortgages.  Then the value of the bundle sinks even more.  In addition the 8% that Big Bob investment firm thought it had coming in from that bundle of mortgages, which it was using to pay John Smith Company on the loan, now isn't coming in (because people aren't paying their mortgages), so Big Bob defaults to John Smith. 

John Smith Company could take the collateral (the bundle), but that now is worth little anyway.  So now John Smith company is in financial trouble because the investment it made (lending for profit to Big Bob) is worthless.  It's a dommino effect, but on a very large scale.

Why did this happen? Tune in next time for some answers.  Some of it may not be what is commonly reported in the news.

We're often asked about the process by which banks foreclose, resell homes and why they can't simply refinance the mortgages.  Some (simplified) answers are below.

How long do foreclosures take? typically 6 months to a year

Why can't a bank just refinance the loan? Some banks 'keep' their own loans, that is, they don't sell them to others. These banks are able to refinance those loans.  Most loans (mortgages) however, are 'bundled' and resold to investors.  It is these investors who ultimately decide if a loan can be 'recast' or revised.

Who are the investors? It's complex, but you could be one! Let's say you own shares of, say, Great Investments Mutual Funds (made up) and one of the companies they have stock in purchased one of these bundles.  Then technically, you are an owner of one of these mortgage bundles.

Many of the biggest investors are overseas.

What about these big banks, like Chase, foreclosing on a lot of properties?: Chase Bank actually has only about 20% of its own loans.  But it is a big 'servicer' of other loans. This means that it, for a fee, collects the mortgage payments, among other duties, for whomever owns the mortgages.  Most servicers also have the responsibilty of the foreclosure/resale process, should it come to that, even though it's not one of their own loan per se.

Most of the big banks 'service' many loans that they didn't 'originate' (make to the borrower).

Why is this affecting our economy when a relatively small percentage of homes (estimated at less than 4%) are in foreclosure?

Because those bundled mortgages were also used as collateral (based on the value of the mortgages) in very big ways to get loans for other investements.  Let's say that some big investment firm called Big Bob bought a huge bundle of mortgages that they thought would net them, say 8%/annum. The cost of that investment, by the way, is very much related to the 'safety' (stability of the homeowners and value of the homes, essentially) of those mortgages.

Then that firm might say "we have this asset worth (let's say) 10M dollars and we are going to use that as collateral for a 5 million dollar loan from John Smith company.  John Smith is happy to give 50cents on the dollar and does so.

But because we were in a housing bubble (all bubbles break) the value of those homes drops and pretty soon, some folks can't refinance or sell because now their mortgage is more than their house is worth.

That means this big bundle isn't worth 10 million anymore.

Even that would be ok, but let's say now some of those homeowners in the bundle can't pay their mortgages.  Then the value of the bundle sinks even more.  In addition the 8% that Big Bob investment firm thought it had coming in from that bundle of mortgages, which it was using to pay John Smith Company on the loan, now isn't coming in (because people aren't paying their mortgages), so Big Bob defaults to John Smith. 

John Smith Company could take the collateral (the bundle), but that now is worth little anyway.  So now John Smith company is in financial trouble because the investment it made (lending for profit to Big Bob) is worthless.  It's a dommino effect, but on a very large scale.

Why did this happen? Tune in next time for some answers.  Some of it may not be what is commonly reported in the news.