Dow Jones on the Paper-It-Over Economy

Dow Jones Newswires breaks an excellent story on Wells Fargo’s efforts to delay its day of reckoning on billions and billions of more mortgage losses, these in ready-to-implode option-ARMs Wells inherited when it bought Wachovia, which inherited them when it bought Golden West, which pioneered the disastrous concept of the “Pick-A-Pay” mortgage.

Now, Wells Fargo is giving its option-ARM borrowers six-to-ten-year interest-only loans to keep them from walking away from their deeply underwater houses with payments that are about to reset much higher. Wells has $107 billion in option-ARM debt and as Dow Jones’s Marshall Eckblad writes, it’s playing “kick-the-can-down-the-road” with some of those loans and hoping an economic recovery someday bails it out.

But Golden West’s loans were concentrated in hard-hit states like California. In order for the median note bought at the peak to get back to even in, say, Southern California, the median price there would have to soar 84 percent from $275,000 to $505,000. Want to bet on that happening over the next six or ten years?

Well Fargo most likely wouldn’t but for the fact that doing so allows it to avoid recognizing the hole blown in its side by the massive losses baked in to those loans. The longer it can string this process out, the more time it has to earn money hand over fist in a low-interest-rate environment to patch up its holes. Never mind that this all probably won’t work and just delays the necessary reckoning of its balance sheets.

There’s another obvious problem with this strategy: If you bought that $505,000 house at the peak, even with this Wells interest-only extension, your payment is still going to be far more than it would to pay the principal and interest in a house selling for $275,000. Even if you can’t get that loan, you’d almost surely pay far less less to rent a similar house (to be sure, Wells didn’t pay full price for the loan book, as DJN points out. It got a 20 percent discount).

Another problem would be that if you get in trouble doing something, it’s probably not a good idea to try to get out of trouble by continuing to do that something. In this case, interest-only or even, probably, negatively amortizing loans have Wells Fargo in trouble, so it’s going to combat that by extending new interest-only loans.

Dow Jones does a really nice job of countering Wells Fargo’s spin.

“We’re banking on the fact the economy will improve and recover over time,” Michael Heid, co-president of Wells Fargo Home Mortgage, said in an interview.

Wells Fargo’s decision to shoehorn thousands of Pick-A-Pay borrowers into long-term interest-only loans helps the bank avoid taking hefty writedowns on Pick-A-Pays that a wholesale push into foreclosures would likely produce. But the strategy will also leave Wells Fargo holding billions in mortgage debt tied to distressed properties in depressed housing markets, especially California and Florida, where the future for property values is hardly certain. Write-offs from Pick-A-Pays, therefore, could bring the bank years of burdensome costs.

This is in keeping with what has been a two-pronged attempt to gloss over the problems in the financial sector, praying it can earn its way out of its giant hole by letting it quit marking assets to market while reinflating an asset bubble.

The positive here is that it could really help people who want to stay in their homes but are getting swamped. The Wells strategy is accompanied by loan modifications, apparently, meaning getting up to that $505,000 example may not be necessary. For example:

One borrower, Danny Annan, an Orange County, Calif., engineer, just finished weighing one of Wells Fargo’s loan modifications. The bank offered to reduce his loan balance by $100,000 and transfer the remaining balance to a six-year interest-only loan with an initial interest rate of about 4.9%, Annan said. The offer will still leave Annan more than $100,000 under water on his home.

There’s more here from Dow Jones, including nice context about the negative-equity landscape. Good stuff.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.