I came away from Barry Ritholtz’ column in Sunday’s Washington Post fairly well convinced that we could see a flood of foreclosure filings over the next year or so. There’s a certain logic to that. While the legal issues for banks and servicers on their foreclosure processes have not ended, the national settlement certainly took state and federal law enforcement off the playing field, giving a lot more certainty to the financial industry. Banks are benefiting from keeping that shadow inventory on the sidelines, which is about the only thing pushing up prices. But there are signs that they will slowly push out more and more borrowers in the months to come.
The first data point supporting this was April’s existing-home sales. That gave us an early clue about what was to come. During the abatement period, distressed home sales, including foreclosures and short sales, had fallen substantially. They were down to 28 percent of existing-home sales for April – significantly less than the 37 percent a year earlier […]
Current foreclosure filings — default notices, scheduled auctions and bank repossessions — increased in May by 9 percent, according to the RealtyTrac monthly foreclosure report.
This was right on cue. With the abatements over, foreclosure starts are creeping up again. As the foreclosure machinery ramps up, the negative ramifications they bring will expand. More distressed sales, lower prices and increasingly tough comparable appraisals are likely over the next 12 months.
Indeed, even in today’s relatively strong news on new home sales, you could see the persistence of the distressing gap, with the normally tight relationship between existing and new home sales broken because of these distressed sales, caused by delinquencies. A renewal of foreclosure operations only exacerbates this.
Ritholtz notes that 2.8 million Americans are 12 months or more behind on their mortgages. Almost all of these borrowers will get targeted for foreclosure, suggesting a potential flood that has serious effects on the economy.
What’s more, they would get added to the close to 10 million already in foreclosure or through the process over the last five years. And those people won’t be able to access the market for a mortgage again, because of the hit to their credit scores. The 16 million families who are underwater are unlikely future participants in new mortgages too. The San Francisco Chronicle detailed how they can barely get away with refinancing at this point. Finally, you have the low rate of household formation that is keeping new buyers off the market, for a variety of reasons. Add that all up, and it’s a significant chunk, perhaps 40-50% of all borrowers, who wouldn’t qualify for credit or who aren’t interested in buying a home. How exactly will the housing market recover given those realities?
Now, some consider this an “overcorrection,” and point to Fannie Mae and Freddie Mac turning down borrowers, even with higher credit scores, for loans. It’s true that credit availability is tighter than in the bubble years. That’s also the right thing to do. First of all, Fannie and Freddie are securitizing about 90% of all loans. Their balance sheet is overloaded, they carry significant risk to the taxpayer, and they are hearing all the rumbling from Washington about how their operations should be shut down. Under the circumstances, I can see how they’d be pretty damn prudent in their lending. There’s no diversification in the market, so this over-reliance on the government to guarantee mortgages leads to this kind of outcome on credit. Finally, given servicer conduct, I’d say those borrowers being denied a loan by the GSEs are being done a favor.
This is at the heart of the credit clog: broken private securitization markets, Fannie and Freddie’s competing agendas, a continued wariness to bargain with servicers in good faith given their conduct, and millions and millions of homeowners having their lives destroyed by the foreclosure machine. And we’re supposed to expect a bounce-back for the housing market?