The Foreclosure Picture Worsens: An Ugly Spiral

The foreclosure picture worsens, with no end in sight, as USA Today reports:

Number of U.S. homes facing foreclosure doubles:

LOS ANGELES — A soaring number of U.S. homeowners struggled to make mortgage payments in the third quarter, with properties in some stage of foreclosure more than doubling from the same time last year, a mortgage data company said Thursday.

Over the years I’ve actually encountered a few people who let their home go through foreclosure instead of selling it and pocketing a profit. Needless to say, most folks are brighter than that, but there have been a few. To lose a house this way would only rarely happen from a bad mortgage alone. For it to be happening on an epidemic scale, then, requires both an inability to make payments and a bad real estate market (let alone a horrible one).

The really abusive sub prime mortgages fed the real estate/housing bubble by allowing many more people to enter the home buying market than would have otherwise been involved in it during the period of skyrocketing prices. There seemed to have been a frenzy mentality that brought the lowering of lending standards to a peak at about the same time that houses really became priced out of reach. This means that many of the people who took out mortgages that really were too expensive for them also bought homes just at the time that the price roller coaster was getting ready to begin the long drop down the other side. Now their payments are getting ready to change to the upside, and their home value has already moved a long way to the downside. When financial bubbles burst the less sophisticated tend to get hit the hardest, and this time is going to be no exception.

With that setting of the stage, let’s talk about how ugly things are really going to get and why. The Fed made its second rate cut for this cycle yesterday, and announced a belief in the possibility that further cuts might not be needed. Then The All Knowing Ones turned around yesterday and made an extraordinary $41 billion injection of liquidity into the capital markets.  With a disconnect like that, do you want to believe what they said, or what they did?

Even without the foreclosure crisis the real estate market would be reeling right now. Largely fueled by speculation, home prices rose to the point where lack of affordability, by itself, would be creating a backlog of unsold homes in most markets. The smart speculators are off counting their winnings, while the folks who didn’t make it to the “Get Rich Quick” seminar until the last part of 2005 are trying to get out from under investments that they have to list for top dollar, because that’s what they paid. In the meantime folks are retiring, getting job transfers, job layoffs, or facing the need to sell homes, for whatever reason, that they are fortunate enough to have strong equity positions in. Some can afford to “lose” thousand of dollars of paper wealth by selling at a reduced price into a weak market, and they do. The few buyers out there are loving it right now, and the sellers who are underwater have no choice but to wait for better times.

And then the tidal wave of foreclosures closes in on nearly every neighborhood in the nation and things go from bad to worse quickly. Foreclosure means that, after an arduous legal process, a mortgage lender owns a particular home and a family no longer does. Remember, if the house was really still worth more than the value of the outstanding financing, by definition, there would be no problem. Lenders hate foreclosures because they lose money on approximately 100% of them. They also hate owning real estate because the product of the mortgage business is money, not real estate. Post foreclosure homes move into “Real Estate Owned” (REO) status and move back onto the market as quickly as that can be arranged. And at whatever price is going to be required to sell, because the industry knows that sitting on a house waiting for a better price almost always results in a bigger loss than dropping the price to wherever it needs to be to move it now.

At this point the folks in the vicinity of a foreclosure home with a house for sell have three choices. Pull it and wait, drop the price and undercut the bank, or pray for a buyer who just wants a nice house to move into instead of a low priced fixer upper. So most will wait. And then another neighbor will have their toxic mortgage blow up on them and another low priced REO shows up on the waiting list that has, right now, no end in sight.

The folks who lose their homes are not good consumers now for obvious reasons, but even the ones more fortunate tend to curtail their spending because their house has already got them in a bad enough position. No sense making matters worse. But matters just keep getting worse because mortgage lenders are still so recently burned that they don’t even want to look at a customer who is not “gold plated”, and the best of the best are never going to be numerous enough to take up the slack as quickly as the inventory of unsold homes keeps building. Oh, and because of the inevitable pull back of consumers the economy goes into the kind of funk that means the real estate market takes further blows from both the demand side and the supply side. Foreclosures skyrocket and buyers stay away from the home market in droves because it makes no sense to buy a house today that can be had for less tomorrow.

Not a pretty tale at all, but the part of this story that remains unspoken by the powers that be is that we are still really only on the front end of this problem. The numbers of sub prime loans that are still waiting to explode, and the chronology of when they were closed indicates that the foreclosure component of this impending disaster won’t peak for about another year, and when it does it may well be at a level two to four times as high as we are being buried by today. Unless, of course, we do something about the problem.

Oh, my next post on this subject will tell you why the other part that no one wants to let out of the bag is the fact that there most probably isn’t anything that CAN be done.

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