By David Dayen
We are nearly eight years removed from the beginnings of the foreclosure crisis, with over five million homes lost. So it would be natural to believe that the crisis has receded. Statistics point in that direction. Financial analyst CoreLogic reports that the national foreclosure rate fell to 1.7 percent in June, down from 2.5 percent a year ago. Sales of foreclosed properties are at their lowest levels since 2008, and the rate of foreclosure starts—the beginning of the foreclosure process—is at 2006 levels. At the peak, 2.9 million homes suffered foreclosure filings in 2010; last year, the number was 1.4 million.
But these numbers are likely to reverse next year, with foreclosures spiking again. And it has nothing to do with recent-vintage loans, which actually have performed as well as any in decades. Instead, a series of temporary relief measures and legacy issues from the crisis will begin to bite in 2015, causing home repossessions that could present economic headwinds. In other words, the foreclosure crisis was never solved; it was deferred. And next year, the clock begins to run out on that deferral.
The problem comes from many different angles. First, as the Los Angeles Times reported recently, home equity lines of credit—second mortgages that homeowners took out during the bubble years, essentially using their homes as an ATM—will start to feature increased payments, as borrowers must pay back principal instead of just the interest. TransUnion, the credit rating firm, estimates that between $50 and $79 billion in home-equity loans risk default because of the increased payments, which could add hundreds or even thousands of dollars to payments a month.
Home equity resets will be concentrated in areas most affected by the housing bubble, because that’s where the most lending took place. These are precisely the areas whose economies remain depressed by the housing bust. So many of these borrowers will be unable to afford increased payments, given the continued high unemployment and stagnant wages in their regions.
That’s only one of a number of scheduled payment resets in 2015 and beyond. The government’s Home Affordable Modification Program (HAMP) provided only temporary interest rate relief to borrowers, and after five years, that relief runs out, with interest rates gradually rising about 1 percent each year. Over 319,000 of these rate resets begin in 2015, according to a report from the Special Inspector General of the Troubled Asset Relief Program (TARP). The architects of HAMP expected the economy to recover by now, but continued sluggishness means that the rug could be pulled out from homeowners before they’re ready for higher mortgage payments.
Many mortgage modifications outside of HAMP were similarly structured as temporary relief, which housing advocates see as a problem. “Many homeowners who fought their way through a broken system and got a modification did not get one that is satisfactory or sustainable,” said Kevin Whelan, National Campaign Director for the Home Defenders League. “One homeowner told me, ‘It’s more like I got a reprieve from a death sentence than a pardon.’”
All told, research firm Black Knight estimates that two million modifications will face interest rate resets in the coming years, and 40 percent of those homes remain “underwater,” where the borrower owes more on the house than it is worth. Underwater homes are highly correlated with defaults and foreclosures, and this represents a giant heap of them, which will soon see what is commonly known as “payment shock”—a big reset in their monthly payment.
Predictably, when the temporary relief fades, homeowners often go back into default. Author Keith Jurow explains that anywhere between 40 and 80 percent of modified loans have re-defaulted over the past several years.
That’s not the only pitfall. As I pointed out in The New Republic last year, mortgage settlements with firms like JPMorgan Chase, Citigroup and Ocwen could impose harm on borrowers. Because the Mortgage Forgiveness Debt Relief Act expired in 2013, and may not ever get renewed, all mortgage relief given to borrowers will get treated as earned income for tax purposes, leaving the borrower with a huge tax bill they are unlikely to be able to afford. The first tax bills reflecting this will come due in April 2015. The most recent settlement, with Bank of America, includes a dedicated fund of $490 million to defray the tax bills. But even Justice Department spokesmen acknowledge that the fund won’t defray all the costs, and that it isn’t large enough to help every affected borrower. So we could easily see some tax-induced defaults as well.
There’s more. Analysts like mortgage servicing veteran Lynn Effinger believe that the foreclosure backlog, most prominent in states that require a court ruling to foreclose, will finally unclog in the coming years. “Many of these loans and their associated properties will emerge from the shadows late this year and early in the next,” Effinger writes.
This may already be happening. Despite the mostly rosy statistics, foreclosure activity did rise 2 percent from June to July after months of reductions, a potentially troubling omen of things to come. Activity jumped 66 percent in Houston and 10 percent in Los Angeles, and foreclosure starts jumped a whopping 128 percent year-over-year in Nevada.
It’s hard to predict just how many additional foreclosures will spring from this scenario: It depends on a number of factors, including whether banks respond to a default wave with additional relief. With two million rate resets, however, and a foreclosure backlog in the hundreds of thousands if not millions, some percentage of those loans will fail. And the fact that harder-hit areas like Nevada and Los Angeles are already seeing a spike is not a coincidence. “It could be bad news in some areas where these are concentrated,” said economist Dean Baker.
Foreclosures ravage communities and hurt the broader economy. They typically lower home prices in a neighborhood, and can even hurt consumer spending and other economic indicators. The same communities that bore the brunt of the crisis the first time around may now experience a second, delayed wave.
This didn’t have to happen. Loans originated since the crisis have performed exceptionally, although efforts to artificially change credit scores to juice riskier lending could change that. This is mostly about the failure to properly fix the crisis when the fire was burning. Obama Administration officials were primarily concerned in their relief efforts with “foaming the runway” for the banks, spreading out foreclosures so they could be absorbed more slowly. That’s why they resorted to fleeting solutions of dubious quality rather than principal reductions, proven as the most effective way to prevent foreclosures. “Getting write-downs was a far more permanent solution than temporary interest rate reductions,” said Dean Baker.
Kevin Whelan of the Home Defenders League believes principal reduction remains a good alternative to prevent the destruction that would accompany a second wave of foreclosures for hard-hit communities. “It’s long overdue but not too late for various parts of the Administration to make much more of this happen,” referring obliquely to Fannie Mae and Freddie Mac, which own or guarantee the majority of the nation’s mortgages and have still not agreed to principal reduction as a foreclosure mitigation strategy.
A second foreclosure spike could stunt the housing recovery and really smash communities just rising from the ashes of the crisis. Permanent solutions could have been explored when it counted to prevent this from occurring. Now we’ll have to hope things don’t go as badly the second time around.
But these numbers are likely to reverse next year, with foreclosures spiking again. And it has nothing to do with recent-vintage loans, which actually have performed as well as any in decades. Instead, a series of temporary relief measures and legacy issues from the crisis will begin to bite in 2015, causing home repossessions that could present economic headwinds. In other words, the foreclosure crisis was never solved; it was deferred. And next year, the clock begins to run out on that deferral.
The problem comes from many different angles. First, as the Los Angeles Times reported recently, home equity lines of credit—second mortgages that homeowners took out during the bubble years, essentially using their homes as an ATM—will start to feature increased payments, as borrowers must pay back principal instead of just the interest. TransUnion, the credit rating firm, estimates that between $50 and $79 billion in home-equity loans risk default because of the increased payments, which could add hundreds or even thousands of dollars to payments a month.
Home equity resets will be concentrated in areas most affected by the housing bubble, because that’s where the most lending took place. These are precisely the areas whose economies remain depressed by the housing bust. So many of these borrowers will be unable to afford increased payments, given the continued high unemployment and stagnant wages in their regions.
That’s only one of a number of scheduled payment resets in 2015 and beyond. The government’s Home Affordable Modification Program (HAMP) provided only temporary interest rate relief to borrowers, and after five years, that relief runs out, with interest rates gradually rising about 1 percent each year. Over 319,000 of these rate resets begin in 2015, according to a report from the Special Inspector General of the Troubled Asset Relief Program (TARP). The architects of HAMP expected the economy to recover by now, but continued sluggishness means that the rug could be pulled out from homeowners before they’re ready for higher mortgage payments.
Many mortgage modifications outside of HAMP were similarly structured as temporary relief, which housing advocates see as a problem. “Many homeowners who fought their way through a broken system and got a modification did not get one that is satisfactory or sustainable,” said Kevin Whelan, National Campaign Director for the Home Defenders League. “One homeowner told me, ‘It’s more like I got a reprieve from a death sentence than a pardon.’”
All told, research firm Black Knight estimates that two million modifications will face interest rate resets in the coming years, and 40 percent of those homes remain “underwater,” where the borrower owes more on the house than it is worth. Underwater homes are highly correlated with defaults and foreclosures, and this represents a giant heap of them, which will soon see what is commonly known as “payment shock”—a big reset in their monthly payment.
Predictably, when the temporary relief fades, homeowners often go back into default. Author Keith Jurow explains that anywhere between 40 and 80 percent of modified loans have re-defaulted over the past several years.
That’s not the only pitfall. As I pointed out in The New Republic last year, mortgage settlements with firms like JPMorgan Chase, Citigroup and Ocwen could impose harm on borrowers. Because the Mortgage Forgiveness Debt Relief Act expired in 2013, and may not ever get renewed, all mortgage relief given to borrowers will get treated as earned income for tax purposes, leaving the borrower with a huge tax bill they are unlikely to be able to afford. The first tax bills reflecting this will come due in April 2015. The most recent settlement, with Bank of America, includes a dedicated fund of $490 million to defray the tax bills. But even Justice Department spokesmen acknowledge that the fund won’t defray all the costs, and that it isn’t large enough to help every affected borrower. So we could easily see some tax-induced defaults as well.
There’s more. Analysts like mortgage servicing veteran Lynn Effinger believe that the foreclosure backlog, most prominent in states that require a court ruling to foreclose, will finally unclog in the coming years. “Many of these loans and their associated properties will emerge from the shadows late this year and early in the next,” Effinger writes.
This may already be happening. Despite the mostly rosy statistics, foreclosure activity did rise 2 percent from June to July after months of reductions, a potentially troubling omen of things to come. Activity jumped 66 percent in Houston and 10 percent in Los Angeles, and foreclosure starts jumped a whopping 128 percent year-over-year in Nevada.
It’s hard to predict just how many additional foreclosures will spring from this scenario: It depends on a number of factors, including whether banks respond to a default wave with additional relief. With two million rate resets, however, and a foreclosure backlog in the hundreds of thousands if not millions, some percentage of those loans will fail. And the fact that harder-hit areas like Nevada and Los Angeles are already seeing a spike is not a coincidence. “It could be bad news in some areas where these are concentrated,” said economist Dean Baker.
Foreclosures ravage communities and hurt the broader economy. They typically lower home prices in a neighborhood, and can even hurt consumer spending and other economic indicators. The same communities that bore the brunt of the crisis the first time around may now experience a second, delayed wave.
This didn’t have to happen. Loans originated since the crisis have performed exceptionally, although efforts to artificially change credit scores to juice riskier lending could change that. This is mostly about the failure to properly fix the crisis when the fire was burning. Obama Administration officials were primarily concerned in their relief efforts with “foaming the runway” for the banks, spreading out foreclosures so they could be absorbed more slowly. That’s why they resorted to fleeting solutions of dubious quality rather than principal reductions, proven as the most effective way to prevent foreclosures. “Getting write-downs was a far more permanent solution than temporary interest rate reductions,” said Dean Baker.
Kevin Whelan of the Home Defenders League believes principal reduction remains a good alternative to prevent the destruction that would accompany a second wave of foreclosures for hard-hit communities. “It’s long overdue but not too late for various parts of the Administration to make much more of this happen,” referring obliquely to Fannie Mae and Freddie Mac, which own or guarantee the majority of the nation’s mortgages and have still not agreed to principal reduction as a foreclosure mitigation strategy.
A second foreclosure spike could stunt the housing recovery and really smash communities just rising from the ashes of the crisis. Permanent solutions could have been explored when it counted to prevent this from occurring. Now we’ll have to hope things don’t go as badly the second time around.
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