Foreclosure or foreplay

One natural consequence of a real estate bubble is a massive wave of foreclosure. The US real estate market was bracing for such a wave since as early as 2005 when economists started to ask what will happen after the ARMs and interest only loans begin to come due at a much higher interest,  5 years down the pike. Interestingly, interest rates have since gone down – thanks in part of the financial tsunami unleashed by the first in memory global-real-estate-induced-financial meltdown. But it is not the interest rates that are causing the massive wave, it is joblessness and the continuing decline of real estate price (not value as some commentators and economists will claim) that is forcing some many home back into the market in less than orderly fashion.

But that was just the tip of the iceberg. A bigger issue started to unfold a few weeks ago when large mortgage banks, under pressure from state attorney generals and an increasing number of personal law suites started to put “temporary” holds on foreclosure proceedings. Early in the week, Bank of America became the third major bank to impose such holds, after Wachovia and JP Morgan Chase, and today, the bank expanded its hold from 23 states to all of the United States!

But what exactly does this mean for the market and how is this likely to affect both home owners and the banks themselves? While thinking about this question and  its implications, it is interesting to note a relatively quiet occurrence on Thursday, when President Obama vetoed a bill that would have given bankers the upper hand in the foreclosure fight. The President stood with consumers and the next day, the largest mortgage banker in the nation (outside of the GSEs) put a hold on all its foreclosures to ensure they proceed legally!

For one, a hold on foreclosure means the banks are worried they may have a problem either wadding through the volume of foreclosures or even just proving their rights or the rights of the investors they represent to those real estate properties. That is huge! And it could play one way or the other. One way all this could play out is that the banks may be more willing to address short-sales and principal adjustments, that they seemed unwilling or incapable of doing the past. Yes, it is true these banks have booked the value (yes they book them as value) of these homes as losses for the most part – which is one of the fundamental reason for the financial crises in the first place, yet, many bankers still continue to believe that these homes will appreciate soon again and that they can all return and smile at the end of the day. If Banks believe that these homes are not likley to appreciate to any where near their record highs anytime soon, they will be more open to negotiating price reductions. Also, if the Banks are convinced that the price of wadding through intractable legal battles is more than the price of mortgage modifications and principal reductions, they will opt for the later.

The other possibility is that the banks will indeed figure out a way or convince themselves they could figure out a way to wade through the morass of improper documentation, and somehow find the will to address all these massive backlog of foreclosures (an estimated 1.2 million in 2010, compared to 100,000 in 2005), and the banks could hold on to their foreclosure bliss. Either scenario will ultimately lead to an inevitable correction in the US housing market. A market where someone earning $60,000 a year is expected to own a home priced at $800,0000. Even on a 40 year mortgage, how could an average home be valued at such a price in such a community – what happened to affordability in the demand and supply equation?

Anyway, the recent news that at least four major banks (including PNC today) are placing a hold on foreclosure is a sign that the housing market is far from its bottom. Those foreclosures will continue to depress the prices of homes regardless of how they are resolved. Indeed, there could be a silver lining in these news in that the Bank executives may opt to hire more hands to deal with the increasing amount of paper work – problem is, those jobs may all be created in India or Egypt. And if they are, I wonder how those Banks will expect to get paid when the people they hope to sell to have no jobs – Maybe they will start shipping the homes overseas as well !

So, this current foreclosure morass may just be a foreplay to interesting times ahead. I just pity the party in power! Hopefully, people will pay attention enough to know that the current Democratic party is better for their long term fiscal health than the tea-bagging Republicans.