Banks have made great progress in dealing with soured mortgages. They have reserved aggressively against various home mortgages and moved to settle related putback issues. But the industry has been less proactive when it comes to second liens.

The New York Times reports that the SEC is taking a harder line on such credits, asking tougher questions about valuations and the like. And that presages more aggressive reserving--perhaps later this year. We presume the regulators are also asking questions of the big banks that hold many first and second liens on properties.

Conflicts of interest arise when a bank or servicer owns a second lien that it originated while it services a first lien that was generated by another institution. People wonder if the servicer is able to protect the revenue stream on the second lien, while foreclosing on the first lien. In normal times, the first mortgage should be paid first by the homeowner, with the home equity loan taking a back seat. The concern is that the outlook for second liens is too rosy in light of the severe stress that has hurt many first liens.

At some point, one would expect all that pain to come home to roost in terms of second mortgages. So it may well be that more banks will be forced to hike their write-offs of second liens and perhaps more first liens.

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