Let The Foreclosures Proceed

I’ve said on more than one occasion that the eventual outcome of the crises in residential and commercial real estate will end when the government either runs out of fixes that don’t work or tires of throwing good money after bad and permits the market to wash out the excess. Whether we’re at that point yet is debatable but it seems to be increasingly clear that we’ve only been putting off the inevitable as opposed to solving anything.

A couple of articles from the NYT and WSJ in the past few days have done a good job of illustrating the futility of recent efforts.

The Times visited Elkhart, Indiana which has seen its real estate market devastated by a poor economy and the excesses of the real estate bubble. What they found was city with improving prospects for business and a real estate market that lives only because of government life support.

Over the next six months, the federal government plans to wind down many of its emergency programs for housing. Then it will become clear if the market can function on its own.

People here are pretty sure the answer will be no.

President Obama has traveled twice to this beleaguered manufacturing city to spotlight the government’s economic stimulus program. The employment picture here has indeed begun to improve over the last nine months.

But Elkhart also symbolizes the failure of federal efforts to turn around the housing slump at the heart of the economic crisis. Housing in this community has become almost entirely dependent on a string of federal support programs, which are nonetheless failing to prevent a fall in prices and a rise in mortgage delinquencies.

More than one in 10 mortgage holders in Elkhart is seriously behind on payments. The median sales price has plunged to the level of a decade ago. Many homeowners owe more than their home is worth, freezing them in place for years. Foreclosures recently hit a record.

To the extent that the real estate market is functioning at all, people here say, it is doing so only because of the emergency programs, which have pushed down interest rates on mortgages and offered buyers a substantial tax credit.

Equally important is an expanded mortgage insurance program run by the Federal Housing Administration, which encourages private lenders to accept borrowers with small down payments. The government takes the risk of default.

Now, you could argue that the Elkhart represents a good example of why government assistance should not be withdrawn. It seems to be at least staving off complete disaster and buying time for a return to normalcy.

That’s where the WSJ article comes in:

More waves of foreclosures will keep downward pressure on home prices in parts of the U.S. over the next several years, two new studies project.

The studies—by John Burns Real Estate Consulting Inc. and Standard & Poor’s Financial Services LLC—both conclude that most efforts to modify loans with easier terms will delay, not prevent, the loss of homes to foreclosure.

The Treasury Department is expected to give its latest update this week on government efforts to avert foreclosures.

The John Burns study estimates that five million houses and condominiums on which mortgages are now delinquent will go through foreclosure or related procedures that put them on the market over the next few years. That would represent the bulk of the estimated 7.7 million households behind on their mortgage payments.

Burns thinks that housing prices will not fall further due to this tidal wave while S&P is of the opinion that it will exert a downward pressure on prices. The Burns study relies on continued investor buying and low interest rates to steady prices. Since mortgage rates are likely to rise once the Fed ends its MBS purchase program this seems like a dubious proposition.

The final piece of the WSJ article is worth noting:

Loan modifications “may be helping marginally, but they are not going to solve the whole problem,” said Diane Westerback, a managing director at S&P.

Loan servicers, firms that collect payments and handle foreclosures, seem to have “nearly exhausted the supply of plausible candidates for loan modifications” and will find that many loans are “unredeemable,” the S&P study says.

As a result, servicers increasingly are looking to arrange “short sales,” in which homes are sold for less than their loan balances.

Is a short sale a foreclosure dressed up? I tend to think so. It might be marginally less costly for the servicers and investors but the end result for the homeowner is the same. They lose their house. I’m not convinced that this is going to prove to be anymore the way out then the preceding programs have been.

But let’s try and get back to where I was going when I started this overly long post. First and foremost, history tells us pretty clearly that asset bubbles eventually have to be popped with all the consequent pain regardless of the intervening efforts to avoid that conclusion. This time will most likely be no different and the two articles I cited would seem to add some credence to that thought.

Moreover, a pretty good chunk of the country is on the road to some sort of recovery. It may not be pretty and it most likely is going to be somewhat jobless but the direction is positive. Depleted government resources are probably best spent assisting in that effort. The ongoing crisis in residential real estate is by and large a problem for four states — Arizona, California, Florida and Nevada — and some pockets like Elkhart. The larger economy is not going to suffer over much if those localities are forced to come to grips with their problems now rather than later.

Rather than risk reinflating a real estate bubble in other parts of the country with continuing government subsidies as well as spending money we simply don’t have, it now makes sense to call an end to the battle and let the final pain wash through. It’s inevitable, so perhaps we should just get on with it.

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