John K. McIlwain, ULI senior resident fellow
There are two palls hanging over the struggling housing market, both of which have been in the news lately. The jobs numbers released this past Friday show unemployment continues unabated even as the federal stimulus program winds down and states and local governments continue to cut back on jobs. The lack of new jobs and the high rate of unemployment especially among the Echo Boomers who should be buying their first homes, estimated by some to be over 30%, will keep household formation, now a quarter of what it would normally be, low and housing demand stalled.
The other bad news for the housing markets is the growing foreclosure mess. The fact that the process has become so sloppy it is verging on the fraudulent should not be a surprise. Banks are expected to start foreclosure proceedings on 1.2 million homes this year, more than last year and up from only 100,000 in 2005. The courts, in those states that require a judicial foreclosure are jammed; there are already some 500,000 foreclosures in process in Florida alone.
Banks and their servicers are processing tens of thousands of new foreclosures each month. Keep in mind that servicers and lawyers handling foreclosures for lenders are paid only a few hundred dollars per loan for handling all the paperwork and filings required; without creating systems with great efficiencies it would be impossible to handle this volume profitably.
Efficiency is one thing, of course, and fraud another. The stories coming to light of “robo-signers,” missing documents, and conflicts as to the ownership of loans point to a system that has or is on the verge of breaking down. Which is why the major banks are putting a hold on foreclosures to see how bad the system has become and what their liabilities are. The probable answer is worse than most think.
Continuing unemployment suggests that foreclosures will continue through this year and next, and longer if the foreclosure process stalls. That said, the underlying fundamentals have not changed. The vast majority of those whose homes are being foreclosed have not paid their mortgages, most because they can’t and some because the values of their homes have fallen so far that they chose not to. The problems underlying the foreclosure mess – due process, fairness, and an accurate accounting of what is due –are important to correct but they will not change the ultimate outcome for most, namely that they will lose their homes.
The result is a growing inventory of foreclosed homes either on the market or being held off awaiting better days for selling them. The greater this overhang and the longer it sits out there, the longer housing prices will continue to fall or a recovery in prices will be stalled.
Which raises the question of whether there is a something the federal government can or should do to help matters? The answer is that there is not much more the feds can do. The HAMP mortgage modification program is beginning to work as well as can be expected and more home owners are qualifying for permanent modifications. Unfortunately, the indication is that many of these permanently modified mortgages are likely to default once again.
There are calls now for a federally imposed moratorium on all foreclosures to protect homeowners while banks, state Attorneys General, and federal investigators sort through the situation. This may be helpful to courts and investigators, and (temporarily) for home owners, but it will do nothing to reduce the growing backlog of homes which in time will be foreclosed and put back out on the market.
There is one thing the federal government could do to somewhat reduce the number of foreclosures: it could require banks (either directly or by means of carrots and sticks) to refinance mortgages on homes which are underwater, reducing the amount of the mortgage to no more than the value of the home, assuming the homeowner can afford the new mortgage. In return, the bank could receive a portion of any appreciation in value of the home on sale. Such a program would not be without its own problems, but it would remove many mortgages from the foreclosure pipeline without increasing bank losses. Unfortunately it is unclear whether this can be done for the majority of mortgages, those in MBS pools, given the contracts that control how special servicers handle mortgages in default for these pools.
Short of this, there is little the federal or any government can do to stem the eventual flow of foreclosures. People without jobs will default on mortgages regardless of modification programs. Foreclosure moratoriums will put things on hold awhile until things are sorted out but not change who owes what on the mortgage.
In short, the overhang of foreclosed homes will remain a drag on home values and will either continue the slow decline in housing prices and stall any recovery. The housing recession will be with us for several years ahead even if the “real” recession has ended.