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Lord, give us a housing market in which foreclosures are initiated and processed quickly and where prices reflect market fundamentals … but not yet. Or anytime soon, really.
With apologies to Saint Augustine, that seems to be the message of an article in The New York Times on Friday, by David Streitfeld:
The Obama administration, in its most recent housing report, said foreclosure activity fell 21 percent in November from October, the biggest monthly decline in five years. Here in Phoenix, foreclosures fell by more than a third in the same period, reflected in the severe drop in foreclosed homes being auctioned on the courthouse plaza. …
If the slowdown continued through this month and into the spring, it could be a boost for the economy. Reducing foreclosures in a meaningful way would act to stabilize the housing market, real estate experts say, letting the administration patch up one of the economy's most persistently troubled sectors. Fewer foreclosures means that buyers pay more for the ones that do come to market, which strengthens overall home prices and builds consumer confidence in housing. …
It is not that borrowers have stopped defaulting on their mortgages. They are missing payments as frequently as ever, data shows. But the lenders are not beginning formal foreclosure proceedings or, when they are, do not complete them with an auction sale. And in the most favorable outcome for distressed borrowers, some lenders are modifying loans so foreclosure becomes unnecessary.
As Streitfeld explains, the slowdown is the result of the increased regulatory and legal scrutiny on the way banks initiate foreclosures.
So, among the positives: fewer houses coming to market, increased consumer confidence in housing, more loan modifications.
There are other considerations too. As Mike Konczal has written, foreclosures are “mini-neutron bombs on property values and neighborhoods.” Not to mention what foreclosures do to households’ credit and wealth, and consequently on their willingness to spend in the rest of the economy.
And to the extent that these delays, by propping up house prices, also limit the number of people who go underwater on their mortgages — well, that helps as well.
Of course, it remains uncertain whether the slowing pace of foreclosures will do much to actually reduce the number of houses that will eventually be foreclosed on. Tom Lawler, as quoted by Streitfeld, is sceptical:
"Whether it is really true that there are millions of foreclosures that could be avoided if servicers were just more willing to do more modifications that make sense "” meaning overall losses would be less than would otherwise be the case "” is far from clear, and in fact highly unlikely," said Tom Lawler, an economist.
Loan servicers are not set up to identify the true financial picture of each borrower having trouble, Mr. Lawler said, and cannot easily figure out who is likely to stop paying without a modification and who will keep sending a check every month.
Given the numerous federal and state investigations into foreclosure practices, not to mention last week’s Massachusetts court ruling, this all means that we can probably expect excess supply to act as a depressing influence on house prices for a while longer.
Of course, that’s the point the article (along with Felix Salmon) is making: rather than house prices falling further immediately, these foreclosure delays and other government interventions serve to hold them steady (or slow the pace of decline), even if it means that it will take longer for the housing market to clear and start rebounding.
Homebuilders are likely aware of what’s happening, which makes us doubtful that they will start building new homes while there are all these other ones waiting to come to market, even if they’re not there yet. Whatever the net impact on the broader economy, it would seem the housing sector won’t see much new activity any time soon.
For a related perspective, have a look at this chart from a recent speech by the NY Fed’s Joseph Tracy:
These estimates are only through Q3, and if the Obama administration’s housing report is correct, then we should see the “newly initiated” part of this graph decline meaningfully in Q4.
Tracy worries that the same forces that are slowing the pace of newly initiated foreclosures are also (for somewhat obvious reasons) slowing the pace at which already-initiated foreclosures get resolved — and this creates problems of its own, especially the incentives it gives to mortgage borrowers. He also points that the foreclosure numbers don’t tell the whole story, for which you must also include the growing number of distressed short sales.
He writes (emphasis ours):
Distressed sales as a fraction of all repeat-sales increased to more than 40 percent after having declined into the low 30s earlier in the year. Some housing economists are forecasting house prices to fall by 10 percent or more this year.
The growing inventory of defaulted mortgages continues to weigh down any recovery in the housing market. According to the most recent Mortgage Metric Report by the Office of the Comptroller of the Currency and the Office of Thrift Supervision, there were 598,000 newly initiated foreclosures in the third quarter of 2010.1 This inflow of new foreclosures exceeded the outflow due to completed foreclosures and properties sold through short sales and deeds in lieu. As a result, the foreclosure pipeline increased to 1.9 million mortgages"”double the level from a year earlier. Efforts to modify mortgages have not managed to prevent the foreclosure pipeline from increasing. As a consequence, distressed sales are expected to grow even further over the coming year.
The combination of declining house prices and increasing delays in the foreclosure process will put upward pressure on default rates as well as losses on defaulted mortgages. CoreLogic estimates that in the third quarter of 2010 there were 10.8 million borrowers in negative equity where the balance on the mortgage exceeds the current value of the property. They estimated that there were an additional 2.4 million borrowers estimated to be in "near negative equity" where the borrower has less than 5 percent equity remaining. Declining house prices will push these near negative equity borrowers into negative equity. This increases the risk that these borrowers will default on their mortgages either out of necessity"”say as the result of a job loss"”or out of choice, which is called strategic default as borrowers determine that there is little economic advantage to keep paying the mortgage. Longer delays in the foreclosure process further increase the incentive for a borrower to strategically default by extending the period of time that they can live "rent free" in the house. In addition, declining house prices increase the expected losses on those mortgages that do default.
There are several things happening here, and we’re not sure we understand all of them or how they interact, so perhaps it’s best simply to summarise.
On the one hand, the decline in the pace of newly-initiated foreclosures (and the delays in processing already-initiated foreclosures) might be good for the economy because:
- Fewer houses come to market, thereby propping up prices (or slowing their decline) - Therefore fewer people go underwater on their mortgages - Foreclosures have a devastating impact on the prices in the surrounding neighborhood - Households preserve more wealth and are therefore more likely to spend rather than save - Consumer confidence in housing increases - More loan modifications (though how many successful ones is unclear) - Time is bought for the rest of the economy to recover
On the other hand, this might not be good for the economy because:
- The problems in the housing market have simply been put on hold, not solved - The excess inventory in the market won’t clear unless prices fall to a more natural level, and the sooner the inventory is cleared, the sooner the housing sector recovers and builders can get started again - It’s unlikely that loan modifications will ever work on a large enough scale to make a difference - Foreclosure delays are a distorting incentive on mortgage borrowers, who will be more likely to strategically default
What else? We have a nagging feeling that there are unintended consequences (or even straightforward expected consequences) that we simply haven’t thought of. What, for instance, is the effect of these delays on labour mobility?
But we also have a feeling that our readers have thought of some, too, so please feel free to set us straight in the comments.
Related links: Negative equity still declining, for now – FT Alphaville Shadow inventory backlog still growing – FT Alphaville Underwater mortgages and US housing "“ FT Alphaville
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