Banks face fresh crisis: How to be a REIT

The White House said on Thursday that President Obama will veto legislation that some say would make it easier for banks to process foreclosures. The threat of what would be the President’s first veto comes as several of the largest banks are being investigated for improperly processing thousands of foreclosures.

This also comes as some of the nation’s largest financial institutions are already strapped with real estate assets and in many cases must now foreclose, take physical possession, and sell property – the sort of labor intensive activity that banks were never meant to handle, Chris Whalen, co-founder of Institutional Risk Analytics, told a packed room at the American Enterprise Institute on Wednesday. “They are not designed to be REITs, but that’s what our banks are becoming,” he said. “We are turning all of our banks, [Fannie Mae] and [Freddie Mac] into owners and operators of real estate, and this stress is going to overwhelm them.”

Whalen demonstrated that banks are already under the same operational stress they were after the last two major recessions, but in this case they’re far from out of the woods. Citing research by Laurie Goodman of Amherst Securities, he said that only 25% of the total number of foreclosures and sales of foreclosed properties have been accomplished. Another presenter at the event, UBS managing director Thomas Zimmerman, said there could be 11.5 million more foreclosures in the next few years, a situation he called “really bad.”

Bank of America (BAC) and Wells Fargo (WFC) were mentioned as institutions to watch, since they face a “mind boggling” flow of property and claims related to securitization activity that will raise the cost of doing business far beyond what these institutions can handle.

In response, Bank of America reiterated points made in September by chief executive Brian Moynihan, who said that the bank was among the few to give detailed liability disclosures. “Just because a loan’s put back doesn’t mean there’s loss in it… they’re manageable numbers, not pleasant numbers but manageable numbers,” Moynihan said during a presentation to analysts. He added that the situation would settle sometime in 2012.

Wells Fargo did not respond to a request for comment.

Pessimism prevails

Whalen delivered his remarks during a particularly grim AEI event titled, “Living in the Post-Bubble World: What’s Next,” where panelists including NYU professor Nouriel Roubini and Mark Fogarty, of National Mortgage News, competed for the title of most pessimistic prognosticator.

Roubini said that even without a double dip recession the global economy will continue to feel like it’s in recession, and that a double dip recession could be triggered by problems in Europe. Desmond Lachman, an AEI resident fellow, agreed that we’re not far away from a major European banking crisis, and said that the euro is going to have to unwind.

Whalen also said that the Federal Reserve is keeping a lid on consumption by keeping interest rates ultra low. While this increases the amount of money banks make on loans, it has effectively transferred about $750 billion in money from consumers and corporations to the banking industry to subsidize losses. You won’t see a pick-up in consumer demand until it ends, he said. “If you take grandma’s money away and she just has enough left to buy food, then obviously the grandkids aren’t going to get nice gifts at Christmas,” said Whalen.

Even so, John Makin, an AEI resident scholar and principal at Caxton Associates, said that the downturn will compel the Federal Reserve to expand its purchase of Treasuries and mortgage securities.

Whalen provided the panel’s tarnished silver lining, saying that the government’s many modification and forbearance programs did not fix problems, but bought us time to figure out the next step. “We have to start restructuring,” he said. “Whoever does that first in the global marketplace is going to be ahead of the game, and I think the United States can do that.”