Why Banks Resort To Foreclosure Auction Even Though It Yields The Lowest Return

Why do banks resort to foreclosure auction when it yields the lowest return? This question is often asked and infrequently answered. I hear the plea all the time as business owners claim they can sell assets for more than a foreclosure auction can yield, therefore reducing the debt for the borrower and the loss for the bank. Same with homes which are frequently auctioned for less than what the borrower was able to refinance for. Never given a chance, they lose the home.

Why this commitment to the foreclosure auction?

The concept has roots in the notion that if the collateral is widely advertised and offered to the whole market in a public forum then surely it must represent fair market value and thus a defensible process by the bank. It is just that – defensible – even though it may yield the least and cost the most and take more time. It is considered fair market value and thus the bank is fulfilling its fiduciary responsibility to the borrower and therefore doing the right thing. More importantly, it cannot be held liable for breaching its fiduciary responsibility to the borrower.

Another issue is the huge negative effect of holding non-performing loans on its books while the borrower attempts to market for a higher price, causing the bank to have to set aside a sizable amount of cash to cover the anticipated loss. This wreaks havoc with its ability to loan and can result in action by the FDIC if the bank holds too many non-performing loans. The sooner it can get rid of the loan and write off the loss the better condition the bank is in. Holding a non-performing loan is worse to the bank auditors than taking the loss and writing it off. The sooner the better so it does not have to be reported and accounted for.

Thees are two important reasons the bank appears to be making the worst decision when in actuality, from their position, they are making the best decision possible.