The final wave of foreclosures proceeding briskly
As loan modifications redefault, and as the market can absorb the supply, lenders are finally foreclosing and resolving their bad loan permanently.
A wave of foreclosures flooded the housing market in 2008 and left millions of homeowners underwater. Most people believe the storm surge receded as lenders ran out of delinquent borrowers to foreclose on, but nothing could be further from the truth. In reality, lenders merely delayed processing millions of foreclosures by can-kicking bad loans in hopes that rising prices could bail out both the bankers and the homeowners with an equity sale.
For the most part, this policy worked. Distressed properties disappeared from the MLS, and fueled by record low mortgage rates, prices rose briskly once the supply was removed.
Bankers designed policies to promote loan modification over foreclosure, specifically to drive down the reported delinquency rates. Further, HUD sold 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 (can-kicking) 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.
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 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 cut 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 is mortgage and foreclosure crisis 2.0 — and it’s now upon us.
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 three 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, and so far, it’s been fairly accurate:
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.
New foreclosures may be back to nearly normal, but the mess from the epic housing disaster in the last decade is far from gone. Bank repossessions, the final stage of the foreclosure process, jumped 66 percent year over year in the third quarter of this year, according to RealtyTrac, a foreclosure sales and analytics company. It’s the largest annual rise ever recorded in bank repossessions by RealtyTrac. More than 123,000 homes went back to the bank in just three months.
Despite the large increase, these foreclosures will generally be metered out at rates the local housing market can absorb. Bankers are finally cleaning up the trash from failed loan modifications given to hopeless borrowers. It’s time to put them out of their misery. (See: Repeat foreclosures result from failed lender can-kicking)
“In states such as New Jersey, Massachusetts and New York, a flood of deferred distress from the last housing crisis is finally spilling over the legislative and legal dams that have held back some foreclosure activity for years,” said Daren Blomquist, vice president at RealtyTrac. “That deferred distress often represents properties with deferred maintenance that will sell at more deeply discounted prices, creating a drag on overall home values.” …
This particular source of foreclosures was expected by most industry insiders. The financial media largely ignored this overhanging supply, so now the East Coast is going to be flooded with the foreclosures they should have processed years ago.
“Additionally, more nonbank lenders who purchased nonperforming loans over the past couple years are moving forward with foreclosure, having passed the foreclosure moratorium of six to 12 months required by many of these purchase agreements,” said Blomquist.
REO-to-rental investment hedge funds exhausted the supply of homes they could acquire at auction or on the MLS for the prices they need to make the investment profitable. Desperate for more homes to add to their portfolios, investors turn to lenders to buy the non-performing loans on their books so these investors can foreclose on the delinquent borrower and obtain a rental property. This new strategy caused a dramatic increase in the number of foreclosures.
With the backlog finally moving, New Jersey now has the nation’s top foreclosure rate, just beating Florida, which was once the poster child for the housing crash and which also has a judicial foreclosure process. Foreclosure activity in the Garden State is more than twice the national average. … bank repossessions jumped 351 percent from a year ago. Atlantic City now boasts the highest metropolitan foreclosure rate.
“The third-quarter increases are a sign that the foreclosure market has settled into a normalized pattern close to or even below precrisis levels, and in those states the overall housing market should easily absorb the additional foreclosure activity with little impact on home values,” added Blomquist.
This is how I see it too. The whole point of can-kicking was to manage the flow of foreclosures once prices were inflated to the peak. This increase in activity is merely the last step in the execution of a brilliant master plan.
Foreclosure activity in formerly hard-hit states, like Arizona and California, is falling. Those states had much swifter systems for processing foreclosures, and investors helped to put a floor on home prices.
“There are so many of them coming so quickly that investor demand hasn’t kept pace with the new supply. That will probably change,” said Rick Sharga, executive vice president at Auction.com, a real estate auction company.
The investors will step up their buying anywhere prices make sense for them to do so.
The Final Wave
The final wave of delinquencies and foreclosures is happening now; 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 process more foreclosures.