Foreclosure Crisis Update
By all accounts and measures, the foreclosure crisis continues to rage. “Foreclosure filings were reported on 937,840 homes in the three-month period, a 23 percent jump from a year earlier, according to a report real estate firm RealtyTrac.” For many industry analysts, this has come as a complete surprise, as it was expected that the government’s loan modification program would have contributed to an (temporary) abatement. That’s not to say that the efforts of the Obama administration have been in vein; rather, it speaks to a change in the underlying dynamics of foreclosure.
In short, the crisis has entered a new phase. Initially, the majority of foreclosures were driven largely by sub-prime and other risky types of loans. As interest rates rose and housing values plummeted, many of these borrowers suddenly found themselves unable to afford the higher payments and defaulted on their loans. At this stage, foreclosures were largely concentrated in bubble regions of the country, where house prices had appreciated faster than justified by fundamentals. This type of foreclosure has been easy to address, although not as easy to prevent. With the support of lenders, the federal government has sought to modify the mortgages for those struggling with higher debt burden. The underlying principle was pretty straightforward: lower payments should translate into lower default rates.
In the still-emerging second stage, foreclosures have begun to crop up among prime borrowers in relative stable housing markets. This trend is unrelated to risky lending practices, but instead, is a product of the economic downturn and rising unemployment. Job losses have exposed the precariousness of many borrowers’ finances, causing them to begin missing payments almost immediately thereafter. As a result, “About 30% of foreclosures in June involved homes in the top third of local housing values, up from 16% when the foreclosure crisis began three years ago…The bottom one-third of housing markets, by home value, now account for 35% of foreclosures, down from 55% in 2006.”
This brand of foreclosure, while easy to identify, is nearly impossible to treat directly. In many cases, unemployed borrowers can’t afford to make any mortgage payment, which means a loan modification wouldn’t do much to ease the possibility of default. The government is facilitating refinancings for mortgages with negative equity, but for most borrowers, this will only forestall the inevitable. Only when the economy recovers and employers begin hiring again will the crisis subside. While the Mortgage Bankers Association (MBA) is projecting that unemployment will peak at 10% in 2010, many analysts expect that the total number of foreclosures will be roughly the same as in 2009.
Even if new foreclosure filings subside, however, there is still an enormous “shadow inventory” of foreclosed properties that hasn’t yet been brought to market. According to a recent report by Amherst Securities Group, “As many as 7 million pending foreclosures could flood the market in the near future, driving housing prices down. That number represents homes that have already been repossessed by lenders or are in serious danger of defaulting….The 7 million units represent 135 percent worth of an entire year of existing home sales, which are pegged at 5.2 million.” Lenders realize that the housing market is still tenuous to try offload more than a small portion of these properties.
“But some economists expect that a wave of foreclosed properties could hit the market in 2010, dampening home prices again,” as self-imposed moratoriums are canceled.
Many homebuyers smell opportunity, and have waded cautiously into the market. The same goes for speculators, some of which are buying foreclosed properties en masse. Others are buying mortgage notes at deep discounts, as part of a gamble that borrowers will be able to repay them after the crisis eases. “The process works like this: A company or its investors purchase a note, then the homeowners get a knock on their door and are given the news about the change of their loan servicer and offered a modification.” As always, these first-movers could potentially reap large windfalls, Still, given that foreclosures have yet to peak, it might be wise to remain on the sidelines, until all of the dust settles.