WORD ON THE STREET: We are all painfully aware that home prices declined precipitously from their peak in 2006 and 2007, resulting in a 32.5% decline. Owner's equity in household real estate fell 53.8% from its peak in 2006.
While house prices are actually increasing in some areas of the country, they continue to fall in the West and Midwest states. According to Zillow, negative equity rose to 28.6% of single-family homes with mortgages in the third quarter of 2011.
Unemployment and partial unemployment remain horrific, at 8.6% and 15.6%, respectively. According to the Bureau of Labor Statistics' latest employment report, 315,000 people dropped out of the labor force, while 120,000 non-farm jobs were created, amounting to a net job loss of around 200,000.
The combination of a recession, a catastrophic decline in house prices and continued unemployment levels not seen since the Great Depression has resulted in a staggering number of mortgage delinquencies, defaults and foreclosures. According to a Dec. 1, 2011, report from Lender Processing Services, mortgage delinquencies are down nearly 30% from their peak, while the foreclosure inventory is at an all-time high. As of October 2011, 2.33 million loans are less than 90 days delinquent, 1.76 million loans are 90+ days delinquent, and 2.21 million loans are in the foreclosure process. This sums to 6.3 million loans delinquent or in foreclosure in October.
The foreclosures rates are correlated with declines in house prices and with state unemployment rates. Clearly, the housing market and high unemployment rates are a drag on the economy. Households have responded by reducing debt levels as a percentage of disposable income, whether voluntary or involuntary.
One of the problems facing the U.S. and global economy is debt saturation. Europe is currently drowning in debt, and the U.S. has serious indebtedness problems to the point where federal debt is growing faster than our industrial production.
This begs an obvious question: Should Congress be encouraging households to take on more debt when bankruptcy and foreclosure allow the opportunity for households to shed burdensome debt?
The remedy for the housing-market collapse and high unemployment rates is twofold: economic growth and getting foreclosed properties back into the economy. However, a series of federal programs, state programs and litigation aimed at slowing the movement of households through the foreclosure process, even when foreclosure is in the household's best interest, are slowing the housing market's recovery.
One such action slowing the recovery is the agreement between federal agencies and large mortgage servicers over alleged borrower mistreatment in the foreclosure process. Servicers would hire independent consultants to review foreclosures over the past two years in an attempt to discern whether borrowers were wrongfully harmed. Based on the outcome of the review, the agencies would then determine what restitution would be provided to the borrowers, if any.
What is the magnitude of the foreclosure review? Apparently, more than 4 million borrowers who lost their homes to foreclosure since they defaulted on their mortgages could potentially qualify for free reviews of their cases. The audits are available to those who were living in their homes and in some stage of foreclosure during 2009 or 2010 and had mortgages serviced by one of 24 companies hired by 14 banks.
The Office of the Comptroller of the Currency (OCC) released its Interim Status Report in November 2011. The report discloses the independent consultants for the review, and there is no reason to believe that these independent consultants will skew or shape their findings to favor the servicers.
Furthermore, given the level of scrutiny on the loan modification process and foreclosures – and the lenders' and servicers' desires to put this process behind them – I am confident that all parties will handle the review process accurately and honestly. My concern is not with the selection of independent consultants, but with the time and costs involved in such a laborious review process relative to the expected economic assessment of harm.
In addition to reviewing foreclosures at the request of the borrowers (and certain mandatory groups), there will also be a sampling of foreclosures to detect problems. Let us suppose that 4.5 million foreclosures are reviewed, and it costs an average of $2,500 per review. If all 4.5 million foreclosures were reviewed, the process would cost $11.25 billion. So, depending on the number of borrowers that ask for a ‘free review’ and the sampling size for all foreclosures, this entire process could be quite costly to lenders and servicers.
More importantly, what would be the penalties for harm done to borrowers relative to the cost? There will likely be egregious errors (such as violations of the law including foreclosure on active-duty military personnel), but I would be surprised if those violations exceed 100 instances (or less than 0.02% of the 4.5 million foreclosures). In terms of modification errors, there are likely to be less than 50,000 instances (or 1.11% of the 4.5 million foreclosures).
In terms of technical errors – such as robo-signing – it is difficult to forecast how many there will be. But technical errors like robo-signing should not result in any financial harm to borrowers, since they would be foreclosed upon after the documentation error is correct.
Suppose that the 100 instances of egregious errors cost $150,000 in financial harm (or $1.5 million). Furthermore suppose that the 50,000 instances of modification errors cost $20,000 in financial harm (or $1 billion). This projected remediation for financial harm is $1.0015 billion (or 8.9% of the total possible cost for the review).
Once the review is completed and the remediation for financial harm is concluded, I urge everyone to put the foreclosure issue aside and allow the market to heal itself.
Dr. Anthony B. Sanders is a distinguished professor of real estate finance at George Mason University, based in Fairfax, Va. This article is adapted and edited from recent testimony Sanders delivered before the U.S. Senate Subcommittee on Housing, Transportation and Community Development. The full testimony is available online.
