Foreclosure Crisis Part Deux

The U.S. housing market may well have been straying through a clearing in the woods, and will soon reach the dark, dense forest, as experts are expecting 2012 to be a monumental year for foreclosures. Five years into the housing crisis, Americans have had to deal with the sub-prime mortgage crisis, robo-signing fraud, foreclosure fraud, refinancing fraud, and fraud on a systemic level ad nauseum with no more than a slap on the wrist given to offenders, while they have seen housing prices drop precipitously without a bottom in clear sight. So it is hard to imagine that the worst may yet be to come. Signs that the shadow inventory, property in forbearance but not yet marked to market on bank balance sheets, will flood the housing market are particularly ominous.

At Reuters, Nick Carey asserts that the faint glimmer of hope for housing market vitals will be extinguished by coming foreclosures. Pundits pushing the resurgence of the U.S. housing market may very well have to explain why the complete opposite is on the horizon.

Five major banks eventually struck that settlement with 49 U.S. states in February. Signs are growing the pace of foreclosures is picking up again, something housing experts predict will again weigh on home prices before any sustained recovery can occur.

Mortgage servicing provider Lender Processing Services reported in early March that U.S. foreclosure starts jumped 28 percent in January.

More conclusive national data is not yet available. But watchdog group, 4closurefraud.org which helped uncover the “robo-signing” scandal, says it has turned up evidence of a large rise in new foreclosures between March 1 and 24 by three big banks in Palm Beach County in Florida, one of the states hit hardest by the housing crash

Although foreclosure starts were 50 percent or more lower than for the same period in 2010, those begun by Deutsche Bank were up 47 percent from 2011. Those of Wells Fargo’s rose 68 percent and Bank of America’s, including BAC Home Loans Servicing, jumped nearly seven-fold — 251 starts versus 37 in the same period in 2011. Bank of America said it does not comment on data provided by other sources. Wells Fargo and Deutsche Bank did not comment.

Housing experts say localized warning signs of a new wave of foreclosure are likely to be replicated across much of the United States.

Online foreclosure marketplace RealtyTrac estimated that while foreclosures dropped slightly nationwide in February from January and from February 2011, they rose in 21 states and jumped sharply in cities like Tampa (64 percent), Chicago (43 percent) and Miami (53 percent).

RealtyTrac CEO Brandon Moore said the “numbers point to a gradually rising foreclosure tide as some of the barriers that have been holding back foreclosures are removed.”

One big difference to the early years of the housing crisis, which was dominated by Americans saddled with the most toxic subprime products — with high interest rates where banks asked for no money down or no proof of income — is that today it’s mostly Americans with ordinary mortgages whose ability to meet payment have been hit by the hard economic times.

“The subprime stuff is long gone,” said Michael Redman, founder of 4closurefraud.org. “Now the folks being affected are hardworking, everyday Americans struggling because of the economy.”

One of the most important aspects of the new foreclosure wave is the last bit, that it has morphed from the sub-prime crisis of 2006. The context for this new kind of crisis are the global recessionary pressures that are forcing many, many Americans, to fall behind on their mortgages because of under or unemployment. At the NY Fed’s Liberty Street Economics Blog, Joshua Abel and Joseph Tracy delve into today’s foreclosures. Sub-prime mortgage loans are no longer the big problem, instead the country’s economic woes have led to prime mortgage defaults.

Abel and Tracy explore the data behind home prices and unemployment to understand the underpinnings of the changing conditions:

They explain that surveying the two graphs above gives a good sense of how economic conditions turned originally reliable homeowners with 30-year fixed rate mortgages into defaulters. Housing prices here are based on the percent change from when the mortgage was signed to when it was foreclosed upon, averaged by year and quarter. The chart above demonstrates that until 2008, local housing prices were still rising. Both unemployment started to rise and housing prices started to fall  at very close times. So the non-prime foreclosures of 2006 and 2007 happened during periods of falling local unemployment rates and rising local housing prices. The 20% decrease in housing prices and mid-single digit unemployment increases reflect on how prime mortgage foreclosures became the majority of the share since 2009. It is no longer just about irresponsible loans to borrowers financially unfit for those loans, but previously stable mortgages are being affected by local unemployment and housing prices.

The authors also correlate the evolution by examining the time before a mortgage went delinquent. They looked at the 25th, 50th, and 75th percentiles of time before missed payments. They also look at the quartile percentiles of FICO scores too, which demonstrate mortgage owners with good credit ratings are being driven to foreclosure and those ratings have plateaued since mid 2009.

Initially, when most foreclosure starts were associated with nonprime mortgages, 25 percent of the borrowers had been in the house fewer than eight months before falling behind on their payments, and 50 percent fewer than eighteen months. However, more recently, as the composition of foreclosures shifted to prime borrowers, 75 percent had been in the house more than three years, and 50 percent more than four years. This suggests that as the recession hit, foreclosures shifted from borrowers who often could not afford their houses to borrowers who had demonstrated that they could (by virtue of making payment for several years) but began to fall behind on their payments when they were hit by the dual crises of house price declines and high unemployment.

This wave of foreclosures hits hard to the core of the housing market and the U.S. economy as a whole. 30 year fixed rate mortgages from reliable borrowers have been turning up with negative equity. The trend rose from 2006 and plateaued in 2009, staying near half the share of foreclosure starts. Policymakers need to tackle the current foreclosure problem as it should tackle the economy, with a robust movement towards lowering unemployment and hoping a construction boom will drive the fundamentals of our economy. Keeping the prime borrowers in their homes may also be of priority via large scale refinancing. The Federal Reserve’s current zero interest rate policy is supposed to be a boon for the housing market, but that impetus just has not been effective. Even with mortgage rates at historically low levels, prospective buyers remain weary. When interest rates inevitably rise, all hell may break loose. Perhaps the rapidly rising cost of renting will drive people to starter homes. But maybe the previously foreclosed houses, now being turned into rentals, will keep prices low and the construction of new homes depressed. The market still needs to clear too, and with the foreclosure hiatus seemingly over, courtesy of a crooked settlement deal, as bad as this little clearing has been,  the dark forest is extremely foreboding.

Southern California real estate expert G.U. Krueger cites USC’s Casden Multifamily Forecast’s prediction that rental growth will continue for the next two years in the area. Krueger explains that the rising rents may push prospective renters into homeownership because of the cost. The story varies widely nationally, but certain areas may The falling number of foreclosures, which in March, as per RealtyTrac, hit a five year low, is keeping distressed homes off the market and further propping up the rental market. But the boom will eventually come, and when the distressed property market gets flooded with foreclosures, the rental market will see its bull run end. Brandon Moore, CEO of RealtyTrac gives his view of the March numbers;

“The low foreclosure numbers in the first quarter are not an indication that the massive reservoir of distressed properties built up over the past few years has somehow miraculously evaporated. There are hairline cracks in the dam, evident in the sizable foreclosure activity increases in judicial foreclosure states over the past several months, along with an increase in foreclosure starts in many judicial and non-judicial states in March. The dam may not burst in the next 30 to 45 days, but it will eventually burst, and everyone downstream should be prepared for that to happen — both in terms of new foreclosure activity and new short sale activity.”

The impending rash of foreclosures must be dealt with though, and eventually the housing market will stabilize to a degree. Perhaps investors will see many opportunities to convert foreclosures into rentals and drive down the price in the rental market. Meanwhile, even though housing prices will fall for the foreseeable future, once the distressed market gets bought up and rehabilitated, neighborhoods once damaged by foreclosures can see elevated prices and rejuvenation.

I suspect the mercurial nature of our economic outlook has a pronounced effect on how prime mortgages may just become an even larger share of foreclosures. Employees can hardly ever be certain they will be, not even at the same job, but employed ten years down the road. Locking into a 30-year mortgage is just something not many people have the privilege of knowing they will be able to pay off. A stable income is less and less the norm for a large swath of the American labor force. This uncertainty for much of the mid to tail end of the millennial generation may create an entirely different and unknown landscape for the U.S. housing market.

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