Why Banks Don't Want to Do Short-Sales

For some time now I have been noticing that the repsonse time and quality of responses from the major banks on short-sales have been deteriorating. Short-sales are just simply taking longer and getting much harder to complete successfully. Bank negotiators seem to be less responsive and negotiations seem to be less flexible. It seems thatmore and more often a home doesn't sell as a short-sale and then a few months later re-appears as a bank-owned foreclosure and sells for less than the offers it received when it was listed short. Why would a financial institution elect to go this route and seemingly lose money?

Last April the government changed the accounting rules for Mark to Market. Essentially what this did was to give the banks more leeway in when they marked down an asset (a mortgage) that was valued at less than its face value. If a bank re-negotiates a mortgage with an home-owner, they must write-down the value of that loan immediately when the loan is re-negotiated. If a bank agrees to sell a property below the mortgage value (i.e. a short-sale) and "forgive" a portion of the existing loan, they must write-down that loan to its short-sale value (less costs of sale) immediately. But while holding a mortgage, even one where the mortgagor is not performing or paying the monthly payments or one where the market value of the collateral (home) is less than the amount owed, the value of the loan as recorded on the bank's books can be the full amount of the mortgage. Real-time mark-to-market has been suspended. Even after a foreclosed property is sold, the bank has some discretion in when it must report the write-down of the loan.

So all this revolves around the timing of the write-off or write-down. For most of us it makes better sense to sell now for more rather than later for less (i.e. take the money and run makes more sense in these cases). However, to the banks, the government requirement that they maintain a certain amount of assets compared to their liabilities (deposits) coupled with the lack of mark-to-market requirements, makes for interesting choices. If they mark down the mortgage (asset) then they have to raise additional capital somehow (likely by selling stock or similar) to compensate and maintain the required asset amounts. The total portfolio of assets and the capital and investment income (stock share price) that these asset valuations can influence apparently is sufficient to trade off a few million (or billion!) dollars of mortgage write-off for time. The banks win and the home-owner / seller (and in many cases the potential home-buyer) loses. I bet that there are periodic bulletins issued inside the banks that tell their negotiators how much of a write-off (in percentage terms) they can negotiate given the forecasted asset to liabilities ratios, etc.