Housing, the engine that has propelled the economy out of past recessions, has become a dead weight in this one, keeping the recovery stuck somewhere between neutral and first gear and threatening to hurl it into reverse.
Housing is “a big reason that the current recovery is less vigorous than we would like,” Federal Reserve Chairman Ben Bernanke observed in a recent speech.
Echoing that concern in his Twitter town hall session, President Barack Obama agreed that the housing downturn “hasn’t bottomed out as quickly as expected,” and acknowledged that administration efforts to break the market’s fall have fallen short.
Few would debate that conclusion. The homebuyer tax credit introduced in 2009 boosted home sales temporarily, but mainly by accelerating home purchases that would have occurred anyway; HAMP, the Administration’s flagship loan modification program, has done little to stem the foreclosure tide.
Improving but Still Not Good
Although mortgage delinquency rates have been declining for several months, delinquencies are falling from extraordinarily high levels. And while the declining delinquency trend is welcome, delinquency rates are still almost double historical averages and foreclosure levels are eight times higher than historical norms.
Foreclosure filings have also been trending downward; new filings fell to their lowest level in almost four years in June, according to RealtyTrac, which would be a welcome sign, if it indicated that fewer homeowners are struggling. But in fact, the decline results more from delays in the foreclosure process than from a significant reduction in the number of borrowers likely to lose their homes.
Allegations of widespread foreclosure processing abuses led many lenders and servicers to temporarily suspend foreclosure actions while they reviewed and revamped their procedures. Courts are demanding more rigorous documentation, some states have enacted regulations requiring mediation as part of the foreclosure process, state attorneys general and federal regulators are demanding additional foreclosure processing reforms, and some of the law firms specializing in foreclosures (and in questionable foreclosure practices) have closed.
The result: A foreclosure backlog of immense proportions. Industry analysts say it takes an average of 400 days to complete a foreclosure, nearly double the average two years ago.
“Foreclosure processing delays continue to mask the true face of the foreclosure situation,” James Saccacio, chief executive officer of RealtyTrac, chief executive officer, said in a press statement. “Even at a significantly lower level than a year ago, the new supply of REOs exceeds the amount being sold each month,” he noted. The company calculated that the number of serious delinquencies and the existing foreclosure inventory exceeded foreclosure sales in the first quarter by a ratio of 50 to 1.
Those bulging REO portfolios, combined with foreclosures in the pipeline and those yet to be filed are creating a shadow inventory that weighs heavily on the housing market, expanding for-sale inventories and depressing already depressed home prices.
Casting a Giant Shadow
“Shadow inventory and real estate owned properties are still playing a dominant role in today’s mortgage market and slowing the pace of economic recovery,” Craig Crabtree, senior vice president and general manager of Equifax Mortgage Services, said in a recent report. “Until these foreclosures are processed,” he said, “the mortgage market will continue to impact economic growth.”
We have in place a cycle that is not only vicious but self-enforcing. The ailing housing market is slowing the economic recovery. The weak economy is reducing demand for housing, keeping housing inventories high and making it difficult for lenders to clear their REO portfolios and their foreclosure pipelines. Weak demand and the continuing foreclosure stream are depressing home prices – further dampening demand, keeping the housing market in the dumps and impeding the economic recovery.
Falling home prices, resulting at least partly from the volume of distressed sales (representing nearly 30 percent of the May sales volume, according to industry statistics) are making it difficult for owners who want to sell to do so — especially if they are underwater on their loans – and keeping prospective buyers on the sidelines, fearful that any home they buy will behave like a car and begin depreciating the minute they complete the purchase.
Reducing the volume of distressed sales “would do a lot for stabilizing the market and helping give people confidence that they can buy and not be buying into a falling market," Fed Chairman Bernanke said in a recent press conference. The problem, of course, is precisely how to do that.
Signs of Stability?
There are some indications that home prices may be stabilizing – perhaps. The closely-watched Standard & Poor’s/Case-Shiller index increased by 0.7 percent in April compared with the prior month – not much of an increase, to be sure, but the first upward movement in this market barometer since last July. Year-over-year, prices were down almost 4 percent in April; compared with the 2006 market peak, the decline is 32 percent – steeper than in the Depression.
Still, analysts were encouraged by the slowing in the rate at which prices have been declined. But they were also hesitant to conclude that the bottom has been reached in a downturn that has seemed to be endless.
“This month is better than last,” David Blitzer, chairman of the index committee at S&P, said in a press statement. But he cautioned that the April increase may reflect seasonal influences (the spring home buying season — such as it has been) more than a change in market fundamentals. “It is much too early to tell if this is a turning point or simply due to some warmer weather,” Blitzer said.
The consensus view is that prices seem finally to be leveling off, but they still have room to fall. Paul Dales, U.S. economist for Capital Economics, thinks prices will decline by another 3 percent this year before they stabilize next year, and he doesn’t see significant price gains until 2014, at the earliest. It will take at least that long, Dales and other analysts believe, for housing demand to strengthen enough to make a dent in bulging inventories.
Tight credit standards are at least partly responsible for preventing the market from gaining any traction, industry executives believe. Nearly 4 in 10 banks responding to an OCC survey reported tighter mortgage lending conditions for the 12-month period ending in February; only 8 percent said they had loosened their standards.
Lenders are mirroring the stiffer underwriting standards imposed by Fannie Mae and Freddie Mac, which continue to purchase the lion’s share of mortgages that are being originated today. Fannie and Freddie have both increased down payment requirements and boosted overall credit standards in an effort to reduce their risks and limit future losses.
According to one industry report, 9 of 10 mortgages Fannie Mae purchased in the first quarter were held by borrowers with credit scores above 700. The credit scores on loans insured by the Federal Housing Administration (FHA) are also climbing, averaging 701 in April compared with 669 three years ago, according to the Department of Housing and Urban Development.
These tighter lending standards are reflected clearly in rising mortgage denial rates. Some industry executives estimate that they eliminate nearly one-third of the borrowers they see – and that doesn’t count the prospective borrowers who eliminate themselves and don’t bother applying for mortgages, because they assume they won’t qualify.
Choking the Market to Save it
Although overly lax lending standards helped to ignite the financial meltdown, there is growing concern that efforts to stabilize the market are in danger of choking it. The combination of risk-averse lenders and overly restrictive secondary market standards has created what one industry executive described as “the most conservative underwriting in 20 years.”
The standards may become even more conservative. The FHA is reportedly considering lowering its debt-to-income ratios; consumer advocates and industry executives are warning that the minimum 20 percent down payment regulators have proposed for “qualifying residential mortgages” under the Congressionally-mandated “skin-in-the-game” requirements for lenders, will further reduce an already skimpy homebuyer spool; and the emergency measure that temporarily increased the conforming loan limits for Fannie and Freddie as part of government efforts to bolster the housing market will expire in October. The reduction in the loan ceiling — from $729,000 to $625,000 — will subject a larger number of loans to higher jumbo mortgage rates, taking another bite out of an already slim home buyer pool.
While the rollback of the conforming loan limit was expected, “I don’t think anyone anticipated some of the numbers that are pointing to further softening of the housing market,” David Stevens, president of the Mortgage Bankers Association and former chairman of the FHA, said. “With no signs of improvement for the foreseeable future,” he told the Washington Post, “this is, unfortunately, an awkward time to be scaling back.”