Denial of Reality – or Refusal

It is now clear that for several years big banks and other financial institutions seriously denied the risks they faced with sub-prime mortgages.  Making so much money from packaging, securitizing, and “insuring” them, they fooled themselves into believing there was little if any risk.  Caught up in their competition with each other, bankers literally lost sight of reality.  But what are they doing now with the toxic assets still on the books?

According to Gretchen Morgenson in Sunday’s New York Times, some version of the problem continues:  “Among the more glaring bookkeeping fictions on big banks’ balance sheets today are the values they assign to all of the bounteous second mortgage loans, doled out during the mortgage bonanza. As any realist will attest, many of these loans are worth little, and yet there they sit, at fantasy levels, on banks’ ledgers.”

But this is not the old denial.  It’s not even a psychological issue.  In this case, Morgenson makes clear, the banks seem to know exactly what they are doing.

The two big federal mortgage giants, Fannie Mae and Freddie Mac, now in receivership, are trying to get banks to pay back the bad loans they are obligated to cover:  “Surprise, surprise: banks don’t want to repurchase these loans. So when Fannie or Freddie identify problem mortgages and request repayment, a battle royal begins.”

Morgenson points out that if “banks refuse to buy back flawed loans, taxpayers will have to cover more of the losses.”  A lot of money is at stake:  “According to March 31 figures from Freddie, for instance, the amount of problem loans that it has asked other firms to buy back stood at $4.8 billion — up 26 percent from $3.8 billion just three months earlier.”  In other words, the banks are becoming increasingly recalcitrant.

To observers who are not psychologically informed, this behavior may look the same as what went before.  But it is vital to discriminate willful behavior from mass delusion.  Morgenson writes:  “denial is a powerful thing, after all, and writing off troubled loans during a period of severe stress is, for bankers, the equivalent of getting a root canal.”  (See “Banks Say No. Too Bad Taxpayers Can’t.”

But this is different from what went on in the euphoria of the credit bubble.  It is more like the “moral hazard” so many feared would be the result of rescuing banks deemed “too big to fail.”  In refusing to pay off their debts, the banks are acting as if they’ve learned that they don’t need to be accountable.

But perhaps it is also a reflection of their increased power.  With friends in the administration and lobbyists in congress, perhaps they have come to feel that they can push back.  They don’t have to do what is against their interests.