Thinking about Foreclosures and the Fauxcovery


Thinking about Foreclosures and the Fauxcovery

What housing data you should look for in the coming months

With a large amount of housing data coming out over the next few days (including the FHFA price data leaked last night), we are likely to see a full range of headlines either proclaiming a continued housing recovery or warning that single data points can’t be considered in isolation. Housing analysts are notorious for their heterogeneous outlook, so this non-convergence of opinion is to be expected. But can we filter through the headline noise to identify which reports are providing the most robust analysis? Sure, just look for the reports that include a comment or two about a coming foreclosure wave-those are the more robust stories.

The reality is that foreclosures are far from having hit their bottom. They declined after the “robo-signing” scandal in late 2010, which revealed that banks were processing foreclosures too quickly. But this slowdown was the result of procedural changes, not resurgent market strength. A recent Barclay’s forecast estimates foreclosures will be rapidly picking up steam going into 2013 and peaking in 2014 before they actually start to dissipate towards the end of 2014 and beyond. We have replicated their forecast to show a few key events that impacted the numbers, below.


One of the main reasons that we have been bearish on housing while many others have been declaring a recovery is in motion is that this new wave of foreclosures is certain to put downward pressure on housing prices. The pressure will be highly localized to areas with more heavily concentrated delinquencies-such as South Jersey, South Florida, Mississippi, and Nevada-meaning some areas will be less effected and see price recoveries in the near-term. The nation as a whole, on the other hand, will have to contend with rising foreclosures and the ripple effect that results-unless of course there is some new intervention in the markets to slow down foreclosures again.

Consider, for example, a little talked-about Massachusetts law that will go into effect November 1, 2012 which gives judges in the Bay State the power to determine whether a bank can foreclose on a distressed home, or if it will be forced to modify the homeowner’s mortgage to avoid foreclosure. As we wrote at last week:

Signed on August 3 by Gov. Deval Patrick, the “Act Preventing Unlawful and Unnecessary. Foreclosures” creates a series of new hoops for banks and other mortgage creditors to jump through in order to foreclose on borrowers who aren’t making their payments.

Under the new law, lenders will have to demonstrate to a Massachusetts court that they made “a good faith effort” to work with delinquent borrowers, and that they took “reasonable steps” to avoid foreclosing. Such “steps” would include considering whether the borrower could make a lower “affordable monthly payment” relative to their current delinquent loan.

These terms are ridiculously arbitrary: “reasonable steps” and “affordability” will be defined very differently by a bank trying to get its shareholder’s money back, versus a homeowner desperately clinging to a roof over his head. Furthermore, they will be interpreted differently by different judges…

The law also requires lenders to prove that they will reap more revenue from foreclosing on the home and selling it in a distressed sale than from modifying the mortgage. At first glance, this provision seems redundant. Presumably a bank would modify a mortgage if they thought they would take fewer losses relative to a foreclosure, even without the government telling them to do so. But the point of the law isn’t to encourage banks to figure out how to profit most from delinquent homeowners, it is to empower judges to tell banks that their estimates on value are wrong.

And though judges will soon have that power, they will be far less qualified to determine value than the banks. For instance, implicit in any assessment of whether a foreclosure will be more valuable than a mortgage modification is an estimate of how much selling the home as a bank-owned property would generate. Banks then compare that to the value of a mortgage modification. Not only will a bank and the court likely have different estimations, but from bank to bank there is rarely a concurrence of opinion on housing market futures. This is just the tip of the iceberg in terms of complicating factors for judges and regulators getting into the mortgage value assessment game.

The new Massachusetts law, similar to legislation passed in states like Nevada and California and drafted in others, distorts market signals in both housing supply and demand, and less obviously in financial lending. If a bank is in fact making erroneous estimates on the value of foreclosures, and taking more losses than it needs to rather than modifying mortgages, then judicial intervention will keep the bank in business that should (and prior to this law, would) be allowed to fail. This hurts future financial institutions that would out-compete the bad banks of today, and means poorer quality service for the local areas those banks serve.

More to this newsletter’s particular point, this intervention in the foreclosure system slows down the process unnecessarily. Rather than bringing a housing recovery to the near-term, slowing down foreclosures delays the inevitable and pushes any real recovery further off into the future. As long as there is a steady stream of foreclosures in the system, there will be downward pressure on housing prices, and that does not characterize a recovery (at least how I would define one). Whether housing price and sales data over the next week are “positive” or “negative”, what really matters is what is going on with the supply of housing and the rate of foreclosures.