Nov232016

Is another wave of foreclosures coming?

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? Americans believe the mortgage and foreclosure crisis of 2008 is over, a misperception fostered by a financial media eager to disseminate good news. Most people were lead to believe an improving economy put people back to work, and those hard-working Americans cured their loans of past-due payments.mortgage-foreclosure-crisis-2.0

Unfortunately, reality differs from the accepted narrative. While the notion of the noble borrower dutifully recovering from the perils of the Great Recession appeals to Americans, 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 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 four years old, and the rate of decline in delinquencies occurred as projected; however, we must revise the chart to reflect the echo bubble of delinquencies resulting from the final resolution of the bad loans of the housing bubble era. The chart below is what I believe will happen:

Projected_mortgage_delinquency_rates_2014-9

Mortgage delinquencies are rising again, and they should 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.

Here we go.

What’s behind a sudden foreclosure spike

Diana Olick, Thursday, 10 Nov 2016squatter_scourge

Foreclosures had been falling steadily to the lowest levels in nine years, but a curious spike in October may be the first sign of a crack in the recovery.

The number of properties with a foreclosure filing, which includes default notices, scheduled auctions and bank repossessions, jumped 27 percent in October compared with September, according to a new report from Attom Data Solutions. The volume is still down 8 percent from a year ago, but annual drops had been in the double digits all year, until now. Government-insured FHA loans are fueling much of the jump.

A one month spike could be random noise. Perhaps lenders anticipated a Clinton presidency and initiated many foreclosures in case she decided to pander to the left and slap a moratorium on foreclosures. If that’s the case, foreclosures should decline again now that Trump won the election.

It could also signify a change in lender behavior. After nearly 10 years of can-kicking, perhaps lenders decided it was time to clear out the delinquent mortgage squatters.

“While some states are still slogging through the remnants of the last housing crisis, the foreclosure activity increases in states such as Arizona, Colorado and Georgia are more heavily tied to loans originated since 2009 — after most of the risky lending fueling the last housing boom had stopped,” said Daren Blomquist, senior vice president at Attom Data Solutions.

Since prices fell from 2009 through 2012, many of those borrowers may still be underwater, particularly FHA borrowers in flyover country.

“The increase in October isn’t enough evidence to indicate a new foreclosure crisis emerging in these states, but it certainly demonstrates that this housing recovery is not completely devoid of risk.”

Something I’ve been pointing out for the last four years…Mortgage Originations by Product

The spike, the biggest monthly jump since August 2007, may be due to a dynamic in the recovery itself: When the mortgage market crashed, and private capital fled entirely, the government stepped in. Government-insured FHA loans jumped from about 3 percent of mortgage originations in 2005 to as high as 18 percent in 2010, according to Inside Mortgage Finance.

These loans, which require just a 3.5 percent down payment, are by definition more risky. Not only do borrowers have far less of a cushion in prices, but the credit score minimum is lower. Borrowers who use FHA loans, which require mortgage insurance, are likely doing so because don’t have the income to afford a higher down payment.

The fact is that Taxpayers insure the riskiest subprime mortgages underwritten today.

“In digging into the numbers among loans that were originated in the seven years from 2009 to 2015, FHA and VA loans account for 49 percent of all active loans in foreclosure. …” said Blomquist.

The share of FHA loans went up considerable in 2008 as FHA replaces subprime, but their share of foreclosures dwarfs their overall share of the market, as one would expect as many of these were subprime.

A second wave of delinquencies and foreclosures is very likely; however, rising delinquencies and foreclosures will not cause another downturn. Even when lenders foreclose on their delinquent borrowers rather than modify 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.

As lenders become more solvent, and as they give up on their most hopeless borrowers, they process more foreclosures. This foreclosure spike should not be a surprise.

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