While many of the “talking heads” and financial experts talk about reaching the bottom of the housing crisis and a slowing of foreclosures, a perfect storm of foreclosures may be on the way. However this “third wave” of foreclosures won’t crash down on the market like a tsunami, but instead will inundate us more slowly like a flooding river.
A number of factors are contributing this flood which will, I believe, spread its damage over many years. Modification efforts and state moratoriums have served to slow the process, and some banks have allowed owners to remain in their homes as “guardians” of the banks declining asset. Other lenders have chosen to delay foreclosures in a struggle to keep the market from free-fall.
Elizabeth Warren, chair of the Congressional Oversight Panel expects the housing market to worsen, and has estimated that as many as 12 million homes could succumb to foreclosure. Here’s why I believe she is correct and why the “green shoots” crowd has it wrong.
● Deutsche Bank has predicted that nearly half of all U. S. homes with mortgages will be underwater by early 2011. Even if their numbers are exaggerated, all experts predict a significant increase in the number of homes with negative equity. As home prices decline, foreclosures increase. The millions who purchased between 2003 and 2008 are at the highest risk of negative equity. Currently, about 11 million homes with mortgages have negative equity with another 2.5 million near that point. The total value of mortgages at risk totals almost $3 trillion.
● Declining values will cause more homeowners to seek “strategic default” as a remedy for their financial problems. As more consumers choose to voluntarily abandon their mortgage, more will consider it an acceptable alternative. And as it becomes evident that some homes won’t recover their value for a decade or more, many who are able to pay their mortgage will choose not to.
● As long as unemployment increases, foreclosures will follow. The third quarter foreclosure numbers were at an all time high, with almost a million homeowners receiving a notice of foreclosure, a 23% increase over 2008. We are currently experiencing about 200,000 foreclosures per month.
● Unemployment will not return to pre-recession levels for at least a decade. How can this be possible? It’s simple math. There are currently more than 15 million unemployed, and hundreds of thousands continue to be added to that number each month; by the time job losses cease, we will have lost a few million more. With the normal growth of our population we add about 1.5 million workers each year. Absorbing that number, plus the millions already unemployed, will require extraordinary growth in the economy, something no experts are predicting. Even if the economy grows at a better than expected rate, a return to full employment (5% or less) is still many years away. If, for instance, we can experience job growth of about 3.5 million jobs per year, it will take a decade to return to previous employment levels; and that is assuming that we can stop the bleeding and begin creating jobs within the next year. Job growth fuels the formation of new households, a necessary component of a robust housing market.
● With unemployment not expected to peak until mid 2010, mortgage delinquencies may not decline until sometime in 2011. The ensuing stream of foreclosures will maintain its pressure on an erratic housing market, spoiling any hopes for recovery until unemployment and foreclosure activity both experience a downward trend.
● There are currently about 8 million delinquent mortgages. The Fannie Mae seriously delinquent rate is now at 4.5%, about three times the amount from only one year ago.
● We also face the Option Arm reset peak coming in 2011 and totaling more than a third of a trillion dollars. According to Goldman Sachs, as many as 50% of those borrowers will be unable to meet the higher payment associated with their loan reset; and a number of these loans are already in default.
● The move-up market, an important barometer of a healthy housing market, will be damaged for years, as those whose homes have lost value will have difficulty selling and will lack the equity required for a move up. The loss of equity also results in a loss of borrowing power. Banks have closed or dramatically reduced HELOCs, the personal ATM of many homeowners, closed some credit card accounts, and raised the interest rates of others. With consumer spending destined to remain sluggish, the ripple effect will ultimately reach back to the housing market.
● Loan modifications, as currently structured, cannot work. As Elizabeth Warren has pointed out, the modification program wasn’t created to deal with the issues we face today. Somewhere between thirty and fifty percent will fail to qualify because of job loss, reduced income, insufficient equity, or inability to document income. And, a great number of the home buyers who purchased during the last decade did so with two incomes; the earnings of both spouses were necessary to meet their obligations. Today, many of those same households have a single wage earner, some of whom are earning less than they did when their mortgage was originated. Unless the program is changed, these people will ultimately lose their homes.
While trial modifications have been extended to about 650,000 mortgage holders, less than 2,000 permanent loan modifications have received final approval. And, a significant number of those receiving mortgage modifications will ultimately re-default, especially those whose homes remain underwater.
Lenders are not making a realistic effort to deal with this problem. I believe some are “foot-dragging,” assuming they may yet receive another “bailout” to help them deal with the potential losses posed by foreclosures. Additionally, the looming danger of commercial defaults, expected to cost hundreds of billions, perhaps as much as a half trillion, is keeping some banks from taking a more aggressive stance towards residential loan modifications.
If the administration is serious about helping millions of homeowners avoid foreclosure, they need to stop talking and develop a plan that works; if they fail to act, a perfect storm of foreclosures may be on the way.
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