Foreclosure Moratorium: A Very Bad Mistake

October 6, 2010

by Mike Simonsen

26 comments

The dominoes are falling, folks, and they’re falling in the wrong direction.

Today the Texas AG moves to suspend all foreclosures to save the innocent homeowners from the big bad banks.  (See Ken Brand for an FAQ on Texas )

Earlier in the week, JP Morgan Chase suspended 56,000 Florida foreclosures to investigate potential paperwork legality issues. Delaware, Maryland, Massachusetts are all rumbling about the BBBs.  More are sure to follow.

This is a bad thing. A very bad thing.

Here’s what’s going on:

  1. People aren’t paying their mortgages. They’re underwater, with onerous payments, may be unemployed, or some combination of the above.
  2. Like it or not, these situations need to be resolved. Resolution is either foreclosure, short sale, loan modification, or get current on your payments. Most likely one of the first two. (Just freezing the process is NOT a solution. Tomorrow morning these people are still in trouble. You won’t be sober in the morning.)
  3. Twenty-three states (including Florida) have foreclosure laws that require a court case to foreclose on a property. These are the so-called “judicial” states. These laws are designed to “protect” homeowners. In other states, the foreclosure process is much more speedy.  The people with legitimate cash to buy homes are much more likely to even try in states where they’re less likely to get tied up in court for years.

As a result, the unintended consequence of heavy foreclosure laws is slower recovery.

Scott posted this image last week illustrating the situation. Looking purely at the inventory trends this year in LA, where it is much easier for the properties to foreclose, clear out, find buyers, investors, and start fresh – vs. Florida where the foreclosure laws prevent that and the homes just sit, unpaid for, unkept, stagnant.

LA Miami housing inventory trends

Active Inventory trends in Miami and Los Angeles

Active inventory in LA is rising much more rapidly than in Miami. In the short term this creates downward price pressure in LA and artificially keeps Florida prices higher than they would be if the shadow inventory were allowed on to the market. Politically, Florida is opting to subsidize/favor the voters with bad loans vs. the ones who may be in the market to buy a home. California is not making that trade. (Not yet anyway. Don’t ever count out California’s political pandering opportunists.) Next year LA is much less distorted by shadow inventory and recovery resumes with the economy. Florida is just left with a bunch of rapidly molding drywall.

Alas, the only resolution is to get the upside-down, delinquent loans closed. Get the properties off the books and purchased by people who can afford them. It’s sad, it’s tragic for the people being foreclosed on. It’s an opportunity for the people who happen to be well financed currently, and for the realtors who help them. And it’s inevitable.

The political/legal hurdles to quick resolution are the basic reason we expect the housing crisis to be a decade-long problem and do not foresee a tsunami of properties coming on the market. It’s a looong trickle. We’re at a crossroads. The country could choose the 1980’s S&L RTC process and get the process done, or we could choose the 1990’s Japan banks process and let it fester for years. Recent news says we’re marching down the wrong path in the name of saving the people.

“We’re from the government and we’re here to help.”

[update] Housingwire illustrates more unintended consequences in the mortgage market.