Rising Foreclosures Continue to Ripple Through Economy

States are trying various coping tactics but want to get funding and regulatory help from Congress.

By Jerome Idaszak, Associate Editor, The Kiplinger Letter

June 9, 2008

The volume of foreclosed homes keeps rising and isn't likely to tail off soon. What began as a problem of large numbers of homebuyers who were delinquent on their subprime mortgages is spreading. More homeowners with credit quality of every stripe are defaulting. Layoffs or a decrease in overtime or regular hours are key reasons.

Moody's Economy.com estimates that this year defaults on primary mortgages will rise to 2.2 million, up from 1.4 million in 2007. By 2009, the number will still be high, hovering around 1.6 million. Though it’ll start to decline in 2010, Moody’s expects the number to remain above 1 million.

This yardstick serves as a "foreclosure alert," says Mark Zandi, chief economist with Moody’s Economy.com. Not all of these will become foreclosures, but it's likely that more than half will, he says. And "foreclosures and delinquencies will be a problem for the rest of this decade," he adds.

Among the states confronting the heaviest stress: California, Florida, Arizona, Nevada, Michigan, Ohio, Maryland, Massasuchetts, Georgia and Indiana. The latest quarterly survey, released June 5 by the Mortgage Bankers Association (MBA), shows a continued rise in foreclosures, with 93% of the increase coming from California and Florida. Those two states saw foreclosure starts in the first quarter at 109,000 and 77,000 respectively. The next highest were Texas, Michigan and Ohio at around 20,000 each.

There are some signs that recently launched programs to reduce foreclosures are having an impact. About 20 states saw foreclosure starts decrease in the first quarter, including Michigan, Ohio and Indiana. Jay Brinkmann, vice president for research with the MBA, says, "We've seen a definite impact from mortgage lenders working with [homeowners]."

But there are limits to how much any of these programs can affect the trend. Most lenders are nationally chartered and that puts them beyond the reach of state officials who want to modify loan terms. Another problem involves the repackaging of mortgages which are then sold as securities to investors in the U.S. and overseas. Attempts to change the terms of the underlying mortgage are almost impossible. Gov. Tim Pawlenty (R-Minn.) says, "One group of investors may own years one through five of the loan; another [group], five through 10; and another, 10 through 15. It's very complicated."

That's why states are looking to Washington for some relief. Mickey Levy, chief economist with Bank of America, says, "Congress should pass a law that clarifies the legal issues so states can negotiate loan modifications with service providers."

Adding to the headache will be the continuing sharp declines in home prices. The nationwide decline on average is about 10% over the past 12 months and still falling. The drop is far greater in many parts of California and Florida, as well as Phoenix and Las Vegas. About 8 million homeowners are stuck in homes that are worth less than what is owed on the mortgages. This negative equity condition is likely to expand to 12 million in 2009 -- or about 20% of mortgages. That will intensify pressure on more homeowners to walk away from their loans.

While states try to slow the pace of homes going into foreclosure, they also are coping with houses that have gone through the process and sit empty. Gov. Ed Rendell (D-Pa.) says his state is looking at ways to buy up clusters of empty foreclosed homes. But, he says, "It's very expensive to demolish houses, and then you have to spend more money to develop the land into a park."

Federal and state aid will help mitigate the situation, but states are experiencing a budget squeeze that is mostly due to a weak economy shrinking revenues from income and sales taxes. Many states are looking to the federal government for funding to get the vacant homes bought and put to use again.

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