The foreclosure problems that have made headlines over the last couple of months have definitely slowed down the process of working through a huge backlog of distressed homes in the marketplace but are not expected to derail the fragile housing recovery as it slowly moves to higher ground in the period ahead, according to participants in an NAHB webinar on Nov. 15.

Speakers agreed that the questions raised about the legitimacy of the foreclosures that have been occurring are largely over intricate procedural matters involving documents and court affidavits and not over the substantive issue of whether home owners are being defrauded of their property. The vast majority of borrowers who are losing their homes are far behind in their payments, with virtually no hope of catching up, they said.

The messy situation “has added another shoe dropping in the middle of many other shoes,” said NAHB Chief Economist David Crowe, referring largely to the disappointing waywardness of the job market, which began cooling midyear just as it appeared to be gathering some momentum.

Questions about the legitimacy of foreclosures have created “more uncertainty in a market that’s already uncertain,” Crowe said. “There will be some pause, hesitance, some slight backward slide, but economic and job growth will save us from that being more than a small hiccup.”

The discontinuity in the flow of foreclosures that the market is now seeing may actually have some small positive impacts on the new home market, he said. A slowdown in the flow of distressed properties coming onto the market will put new homes in a slightly better competitive position, and the foreclosed properties that are pushed out further into the future will find more buyers to the extent that economic and job growth have improved.

“Most of these foreclosures are going to go through,” Crowe said. “There are no substantive reasons why the process won’t eventually take place. It’s mostly paperwork, people forgetting to do their job and an overwhelming number going through a system not able to deal with this flow.”

Crowe pointed out that foreclosures are highly concentrated geographically, with Florida accounting for 23% of all the foreclosures in the country and 11 states responsible for nearly 70% of them. Although they tend to be the smaller housing producers, there are a number of states whose housing markets are poised to return to normal conditions.

There are also as many as two million households that did not form during the recession because of job losses and job fears, he said, and those individuals “are right at the edge. All they need is to get a job and they will be out buying a home or renting an apartment, absorbing one more vacant unit.”

Crowe voiced confidence that mortgage rates will remain relatively low during this transitional period for housing, which will help make purchasing a home attractive and counterbalance a relatively slow economy and reluctant consumers. Job formations are not expected to develop a full head of steam until 2012, when they should rise to a monthly pace of about 200,000.

Paperwork Problems

As a result of concerns over paperwork problems, “the foreclosure process probably will take more time,” said Laurence Platt, partner, K&L Gates LLP. “There will be some backtracking to do things appropriately and some uncertainty and hesitancy among those who would have bought a foreclosed home, who might bid a little lower for some of those properties until this process is clarified.” It is still not clear “what the states will do, how judges will react and how much disturbance this will cause,” he said.

From a legal perspective, Pratt discussed several of the issues behind the brouhaha over foreclosures, which range from the validity of transferring the ownership of the mortgages to problems with improperly notarized signatures on documents appearing in court. The issue has not been “about whether the borrower actually defaulted or was eligible for foreclosure.”

“What happens when you find these procedural issues but the borrower is otherwise eligible for foreclosure?” he asked. On the issue of questionably notarized affidavits, most are filing new ones and “they think it is good enough, but they are not sure.”

Also yet to be determined in many places is whether the foreclosure holds its place in line or has to start over again in a process than can take 18 months to resolve from the time of the default.

The situation has created a “policy conundrum.” On the one hand, looking at mistaken representations before them, “the courts want to enforce respect for their process.” On the other hand, there is concern over freezing the housing markets at this critical time and calling into question the legitimacy of a mortgage securitization process in which these loans are guaranteed or owned by the government.

In the end, the government ought to be on the side of enabling eligible buyers to purchase this troubled real estate. “It is important to side with people who are reinvesting in the communities,” he said. “If delinquent borrowers are chosen, this will cause long-term economic pain.”

The government ought to be concerned about “timely foreclosures when there are no more alternatives,” such as loan modifications, Platt said. “Flush the houses through the system and let new borrowers come in and get new mortgages. Clean up your paperwork wherever you can, but don’t stop foreclosing.”

A Housing Overhang

Robert Hunter, vice president, Amherst Securities Group LP, said the overhang of distressed housing is growing, and he presented numbers that were staggering.

Hunter said there is a potential for 7.2 million foreclosures this year and almost 11.6 million mortgages could be in distress in the next year or so:

• There are currently 5.2 million loans that are non-performing, 90 days past due. Of these mortgages, 95% — or 4.94 million — will default.
  
  
• On top of that, another 3.2 million mortgages are re-performing, which means they have been modified over the past three or four years. About 70% of these — or 2.3 million — could eventually lapse back into distress.
  
  
• There are 2.6 million mortgages that are underwater with loan amounts that are at least 120% greater than the value of the home. Half of them — or 1.3 million — could become problems.
  
  
• Another four million homes are slightly underwater with loan-to-value ratios between 100% and 120%. Of these, 25% — or one million — are in jeopardy.
  
  
• And there are 40 million loans that have always been performing and that have LTV’s of 100% or less (averaging 90%). Typically, 5% of these go into default, which would equal two million loans.

The picture has continued to deteriorate this year, according to Hunter. At the beginning of 2009, 10% of all home mortgages were non-performing or re-performing. That share is now 15.3%, and 10% of those are non-performing.

The supply of distressed housing is troubling in many locations. In New York-White Plains-Wayne, N.Y.-N.J., the worst market in the nation by far, there was more than a 95-month supply of distressed homes at the beginning of September, he said. In San Bernardino, there was almost a 28-month supply.

The length of the time it takes to liquidate bad loans has also been rising — from 15 months from the time of default at the end of 2008 to 21 months this September.

Loans 18 to 24 months past due rose from an 8% share of all defaults at the end of 2008 to 29% now. The share that is 18 months past due has gone from 23% to 54% over the same period. Delinquent borrowers “are not being rushed into foreclosure because they are three or four months past due,” Hunter said.

In Florida — the state where the process takes the longest — the liquidation period has climbed from 17 to 27.2 months. “This is before the problem with the foreclosure freeze,” he said.

With 462,000 housing units in foreclosure in the courts at the end of June, Florida took steps to speed up the process and as a result was able to dispose of 65,000 units in the following quarter. “At this pace, it will take seven quarters to liquidate just the backlog of what is in the foreclosure system,” he said, and another quarter or so will probably be added in the next few months because of the freeze.

Hunter predicted that the cost of borrowing will be going up for mortgages across the board as the result of the additional regulations and disclosure rules being imposed on lenders. Also, because “investors in the secondary market have all been burned,” their “risk aversion is much different these days.”

On the plus side, mortgage rates are the lowest they have been going back to the Eisenhower era and mortgage originations are profitable, he said. There is also a pickup in borrowers who have not been in distress and have been prepaying their mortgages. “The lender is getting their money back, and that’s a borrower who will be back in the marketplace.”

Crowe added that there were 6.22 million foreclosures and delinquencies in this year’s second quarter, and the pipeline remains large, but there are signs that these troubled loans have begun to taper off.