FDIC: Worst Market Since the 1930s

Posted under Foreclosures, Real Estate, Recession, Short sales by Darren Hom

Take a look at what the FDIC wrote concerning the housing crisis (emphases mine).

We are now undergoing a self-reinforcing cycle of default, foreclosure, home price declines, and mortgage credit contraction, the likes of which we have not experienced since the 1930s. The annual number of U.S. foreclosures nearly doubled between 2005 and 2007 to more than 1.5 million, and some private forecasts project 2 million foreclosures or more during 2008 if action is not taken now. Beyond their immediate costs, which include hundreds of thousands of displaced families and tens of billions of dollars in financial losses, these defaults and foreclosures are now resulting in wider problems for our communities and our economy.

When this happened in the early 1990s, the FDIC helped shut down banks and liquidate their assets. Now it says we’re facing a crisis that’s even worse. If bank failures begin again in earnest, the FDIC will have a lot of work on its hands.

Home prices in ten large U.S. cities fell on average by 13.6 percent in the year ending in February, and home price declines of more than 15 percent were registered in major metropolitan areas of California, Nevada, Arizona, Florida, and Michigan. A large inventory of unsold homes points to a protracted oversupply of homes. Of the net 6.6 million homes added to the U.S. housing stock since 2004, more than half are currently vacant. The problem is made worse by the difficulty of securitizing mortgage debt outside of the government-sponsored enterprises. The data show that private MBS issuance in the fourth quarter of 2007 was down 80 percent from the same quarter the year before, and originations of nonconforming loans financed by private mortgage backed securities (MBS) declined by similar amounts.

More than half of the unsold homes are vacant. That’s 3.3 million empty houses. Empty houses are eventually attacked by weather, vandals, and squatters. What will happen to property values then?

Because of the high costs associated with foreclosure (which can range up to 40 percent of the value of the property), it is in the interest of both borrowers and lenders to avoid this remedy whenever possible. But the progress of loan modifications to date has been too slow. A recent study indicates that seven out of ten seriously delinquent borrowers are not yet in any loss mitigation process, and that new loans are becoming delinquent faster than the servicers can modify them on their own.

Loan modifications are going to be an important part of bringing the housing market to a recovery point. I don’t think it’s the government’s job to make sure that these modifications take place. Rather, lenders have every reason to preserve themselves financially by increasing the efficiency of their loss mitigation efforts and by selling their problem loans to investors who are skilled at dealing with delinquent loans.

Subsidizing lenders who are unable to do this simply subsidizes their irresponsible lending choices and business practices. Subsidizing homeowners who put nothing down and are now in distress has the effect of penalizing homeowners who used substantial down payments to buy their properties but have lost most or all of their equity. (See Richard Martens’ post on homeowner bailouts.)

Investors are already responding to lenders’ needs by doing short sales, buying REOs, and purchasing pools of unwanted mortgage paper. Profits exist where lenders need help, and the strength of that need is going to increase through the coming recession.