Looking Beyond the Foreclosure Hysteria

After a week of mass media hysteria there are at least a couple voices of reason starting to speak out with regard to the foreclosure crisis. Steven Pearlstein writing in the WaPo adds some needed perspective.

Listening to the fiery rhetoric about the mortgage mess emanating from politicians this week, you’d think that big bad banks were trying to foreclose on hundreds of thousands of homeowners who were current on their payments but had become victims of sloppy business practices. If that were the case, declaring a national moratorium on foreclosures would be the just and reasonable thing to do.

But if, as appears to be the case, the overwhelming majority of homeowners facing foreclosure have fallen far behind on their payments, then it is a good deal harder to summon up the same moral outrage over reports that the banks and loan service companies cut corners, failed to keep the right documents and engaged in shoddy and even fraudulent practices. Just because the banks and servicers have screwed up doesn’t mean they and their investors are no longer entitled to get their money back.

Certainly banks and servicers should, at their own expense, be sent back to do things right. Those who engaged in fraud should be punished. And if there are legitimate questions about who owns a loan, those will need to be resolved before the proceeds of any foreclosure are distributed.

But none of that changes the basic reality that there are millions of Americans who took out mortgages they could not support on houses they could not afford. It may be necessary to postpone their day of reckoning for a few months to get the paperwork in order and ensure that all the proper procedures are followed, but the reckoning is inevitable.

Now that doesn’t mean that there aren’t people still looking to pile on here in hopes of some gain – financial or political. Those self-appointed guardians of all, the state attorneys general, are reported to have banded together to launch an investigation of the banks. Just the sort of complication that will string out the mess, and the longer this festers the more harm there will be that will accrue to the housing market and the overall economy.

What’s going to be the fallout? It’s anyone’s guess. John Lounsbury writing at Credit Writedowns suggests the following repercussions:

Home sales drop , but prices rise; then

Inventory floods the market as title issues are resolved; then

Home sales rise, but not enough to meet the supply; then

Home prices plummet.

He thinks that we will see a rise in prices initially as the inventory of homes that title insurance companies will insure shrinks and buyers are faced with a depleted inventory from which to choose. Maybe, but that presupposes that purchase activity won’t evaporate as buyers despair of being able to properly assess the fairness of any price.

Personally, I think that anyone buying now or contemplating buying would be a fool to move forward. There is simply no way to know what the impact is going to be. For instance, suppose that the solution is a government imposed modification program. Logically, that’s going to draw millions of more underwater homeowners into default as they seek to cash in on the deal. So the lottery winners will win but at the price of pulling the entire market even lower than it might have been had foreclosures proceeded apace.

It’s hard to see how any of this gets resolved before the first of the year. Certainly, nothing is going to happen prior to the November elections. Possibly Congress tackles it as the lame duck session resumes thereafter but they have a lot of other things on their plates when they come back. And the longer it takes to reach a resolution the more convoluted the situation will become.

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