Why Foreclosures Rise Even as the Economy Expands

The Mortgage Bankers Association says that home loan delinquencies have set a new record.

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Even as the U.S. economy expanded in the third quarter, the nation's eroding labor market sent the mortgage delinquency rate to new heights and created fresh headaches for the Obama administration. About 1 in every 7 home loans in the country was either past due or in foreclosure at the end of the third quarter, according to the Mortgage Bankers Association's most recent National Delinquency Survey. That's the highest delinquency rate in the survey's history (the data begin in 1972). "Despite the recession ending in midsummer, the decline in mortgage performance continues," said Jay Brinkmann, the MBA's chief economist. "Job losses continue to increase and drive up delinquencies and foreclosures because mortgages are paid with paychecks, not percentage point increases in GDP." Here are six things you need to know about the development:

1. Moving upstream: The MBA report provides an inside look into the evolution of the foreclosure crisis. Initial problems in the mortgage market were largely rooted in subprime loans and other exotic products. But with the national unemployment rate hitting 10.2 percent last month, the eroding labor market has emerged as the most fundamental factor behind the mortgage crisis. A job loss, after all, can prevent even borrowers with sound credit histories from paying the mortgage. "The infection is spreading out, and it is now prime borrowers that are in trouble," says Mark Zandi, the chief economist at Moody's Economy.com. From the third quarter of 2008 through the same period this year, the rate of foreclosure starts increased 0.53 percentage points for prime loans—made to borrowers with good credit—while it fell 0.47 percentage points for subprime loans, the MBA said in the survey.

[See Foreclosure Epidemic Reaching More Expensive Homes.]

2. Regional concentrations: Regional concentrations of problem loans are striking. Nevada, Florida, Arizona, and California—four states at the center of the housing boom and bust—accounted for 43 percent of all third-quarter foreclosure starts. In addition, 1 in every 4 home loans in Florida is either past due or in foreclosure. "That's an amazing number," says Patrick Newport, US economist at IHS Global Insight.

3. Shadow inventory: The figures are a discouraging development for a housing market that has demonstrated recent—if tentative—signs of stability. While the National Association of Realtors' existing home sales report shows that the backlog of unsold properties has decreased in recent months, future foreclosure sales will ensure that a steady supply of discounted homes hits the market in coming years. "We continue to believe that nearly 6 [million] foreclosed homes will enter the market over the next three years, which will keep inventory of existing homes elevated," Michelle Meyer, an economist at Barclays Capital, said in a report. "Foreclosures remain the biggest hurdle to the housing recovery."

[See What's Behind the Foreclosure Decrease.]

4. Hole in the rescue: It's important to note that mortgage delinquencies continue breaking records in the face of Uncle Sam's sweeping effort to keep struggling borrowers in their homes. Although the initiative has put more than 650,000 borrowers into trial modifications, there is growing concern that the Obama administration's initiative isn't well suited for today's housing crisis. For example, although unemployment is the key force behind current delinquencies, borrowers who can't make mortgage payments on account of a job loss can't participate in the program. Observers in growing numbers have called this a key shortcoming of the Obama administration's housing rescue. "It increasingly appears that [Uncle Sam's housing rescue] is targeted at the housing crisis as it existed six months ago, rather than as it exists right now," a congressional oversight panel said in a report released October 9. In addition, the effort does not sufficiently address the issue of borrowers with are significantly underwater—meaning they owe a great deal more on their mortgage than their home is worth, Zandi says.

5. Modifying modifications: On account of these issues, "it is important for policymakers to consider how to modify the modification program so that it can work better," Zandi says. One possibility could be through programs that allow struggling borrowers to relinquish ownership of their property but remain there as renters. Similar efforts have been launched at Fannie Mae and Freddie Mac.

[Check out How Struggling Homeowners Can Stay in Their Homes as Renters.]

6. Reversing the trend: Mortgage delinquency rates aren't expected to stabilize until the labor market does. Newport expects the unemployment rate to peak in the first quarter of 2010 at roughly 10.5 percent. But even after the unemployment rate peaks, don't expect delinquency rates to shoot back to earth immediately. "The [delinquency] rate is going to stay up there for quite a while because the job market is going to be really weak for a while," Newport says.