Mortgage and foreclosure crisis 2.0
The mortgage and foreclosure debacle of 2008 was cut short by government intervention. A second round of deferred distressed sales is yet to hit the market.
Is the mortgage and foreclosure crisis resolved or merely delayed? Most people believe the mortgage and foreclosure crisis of 2008 is behind us, a misperception fostered by a financial media eager to disseminate good news. The common perception is that an improving economy has put people back to work, and those hard-working Americans cured their loans of past-due payments: all is well.
Unfortunately, that isn’t the reality. While the notion of the noble American borrower dutifully recovering from the perils of the Great Recession is appealing, most borrowers were overextended before the recession hit, and lenders made deals with these borrowers to preserve the bad debts polluting the balance sheets of both bankers and borrowers.
These loan modification deals merely postponed the final resolution until a day when the value of the collateral backing these bad loans was restored. The final resolution of these can-kicked loans will be mortgage and foreclosure crisis 2.0.
Back in July of 2012, I noted that Foreclosures dominance of housing market projected to end in 2015 or 2016:
I took the long-term chart of mortgage delinquencies from LPS and projected the current rate of decline forward to the future to see when we get back to a normal rate of delinquency. The result was January of 2015 (see chart below).
The data series for extrapolation was two and a half years of data, and the trend is easy to define. I feel confident that unless lender behavior changes, we will see normal delinquency rates by early 2015. …
The chart above is over two years old, and the rate of decline in delinquencies has occurred as projected; however, it’s time to revise the chart to reflect the echo bubble of delinquencies to come as the bad loans of the housing bubble era are finally resolved. The chart below is what I believe will happen:
Mortgage delinquencies will rise again, and they will remain elevated above historic norms for much longer than anyone currently anticipates. This will “surprise” economists and others who accept the financial media spin without understanding why and how the mortgage delinquency rates were lowered in the first place.
We are nearly eight years removed from the beginnings of the foreclosure crisis, with over five million homes lost. So it would be natural to believe that the crisis has receded. Statistics point in that direction. Financial analyst CoreLogic reports that the national foreclosure rate fell to 1.7 percent in June, down from 2.5 percent a year ago. Sales of foreclosed properties are at their lowest levels since 2008, and the rate of foreclosure starts—the beginning of the foreclosure process—is at 2006 levels. At the peak, 2.9 million homes suffered foreclosure filings in 2010; last year, the number was 1.4 million.
This is the perception created by the financial media. Bankers designed policies to promote loan modification over foreclosure, specifically to drive down the reported delinquency rates. Further, HUD has been selling off non-performing loans to hedge funds that don’t report their delinquencies, which also lowers the reported rate.
Lowering delinquency rates should be a big plus; however, lowering delinquency rates through methods that don’t permanently cure the loan is a farce designed to influence public perception. Lenders want to report better delinquency rates to improve confidence in the housing market to encourage buyers to bid up prices to aid lenders in their capital recovery on their bad loans. Politicians want HUD to report better rates purely for public relations benefits to improve their approval ratings.
But these numbers are likely to reverse next year, with foreclosures spiking again. And it has nothing to do with recent-vintage loans, which actually have performed as well as any in decades. Instead, a series of temporary relief measures and legacy issues from the crisis will begin to bite in 2015, causing home repossessions that could present economic headwinds. In other words, the foreclosure crisis was never solved; it was deferred. And next year, the clock begins to run out on that deferral.
I’m thrilled to see the financial media finally pick up on this. I’ve written many articles making this point including most directly Today’s loan modifications are tomorrow’s distressed property sales, and The final resolution of loan modifications will push people out of their homes.
The problem comes from many different angles. First, as the Los Angeles Times reported recently, home equity lines of credit—second mortgages that homeowners took out during the bubble years, essentially using their homes as an ATM—will start to feature increased payments, as borrowers must pay back principal instead of just the interest. TransUnion, the credit rating firm, estimates that between $50 and $79 billion in home-equity loans risk default because of the increased payments, which could add hundreds or even thousands of dollars to payments a month. …
The HELOC reset and recast issue will not create a second mortgage crisis, but it will create a second round of lender can-kicking loan modifications. (See: Upcoming mortgage resets and recasts prompt more loan modification can-kicking)
The government’s Home Affordable Modification Program (HAMP) provided only temporary interest rate relief to borrowers, and after five years, that relief runs out, with interest rates gradually rising about 1 percent each year. Over 319,000 of these rate resets begin in 2015, according to a report from the Special Inspector General of the Troubled Asset Relief Program (TARP). The architects of HAMP expected the economy to recover by now, but continued sluggishness means that the rug could be pulled out from homeowners before they’re ready for higher mortgage payments.
Many mortgage modifications outside of HAMP were similarly structured as temporary relief, which housing advocates see as a problem. “Many homeowners who fought their way through a broken system and got a modification did not get one that is satisfactory or sustainable,” said Kevin Whelan, National Campaign Director for the Home Defenders League. “One homeowner told me, ‘It’s more like I got a reprieve from a death sentence than a pardon.’”
The people in the HAMP program have less to worry about because HAMP loan modifications will become permanent housing subsidies.
It’s hard to predict just how many additional foreclosures will spring from this scenario: It depends on a number of factors, including whether banks respond to a default wave with additional relief.
Obviously, they will. (See: Upcoming mortgage resets and recasts prompt more loan modification can-kicking)
With two million rate resets, however, and a foreclosure backlog in the hundreds of thousands if not millions, some percentage of those loans will fail. And the fact that harder-hit areas like Nevada and Los Angeles are already seeing a spike is not a coincidence. “It could be bad news in some areas where these are concentrated,” said economist Dean Baker.
Foreclosures ravage communities and hurt the broader economy. They typically lower home prices in a neighborhood, and can even hurt consumer spending and other economic indicators. The same communities that bore the brunt of the crisis the first time around may now experience a second, delayed wave. …
A second wave of delinquencies and foreclosures is very likely; however, rising delinquencies and foreclosures will not cause another downturn. In the post Is San Francisco, the most overvalued US housing market, going to crash?, I challenged housing bears to construct a realistic scenario where house prices crashed, and I still stand behind my conclusion: “As long as supply continues to be restricted and the percentage of all-cash purchases is high, prices simply won’t go down. Sales volumes may continue to decline, but prices will remain suspended where more buyers can’t afford them unless something changes at the banks and they begin approving more short sales or foreclosing on their delinquent borrowers rather than modifying their loans.”
I want to add one nuance to the above observation: even when lenders do start foreclosing on their delinquent borrower rather than modifying their loans again and again, the rate at which they process these foreclosures will be slow enough for the market to absorb them without pushing prices lower.
Slowing the sales rate of must-sell inventory is the key to preventing housing market crashes. It’s the reason can-kicking began in 2009, and it’s still the focus of all lender policies toward resolving bad loans now.
Lenders would like to kick the can until prices reach the peak in order to avoid recognizing any losses. Eventually, lenders will realize this fantasy will not become reality, and unless they do something, some of their bad loans will never be resolved. As they become more solvent, and as they give up on their most hopeless borrowers, they will begin processing more foreclosures. It’s just a matter of time.