October 15, 2010 / 8:25 PM / 9 years ago

Analysis: Foreclosure logjam hits housing, broader economy

WASHINGTON/NEW YORK (Reuters) - The fragile U.S. economy will probably sustain another blow as a result of the latest housing market crisis.

Amid allegations of wrongful evictions, lenders such as Ally Financial’s GMAC, JPMorgan Chase & Co and Bank of America Corp have halted at least some of their foreclosures in process, creating a bottleneck that has the potential to restrain both bank lending and consumer spending.

The U.S. recession came to an official end in June of 2009, but it has yet to sustain a meaningful recovery, as unemployment persists above 9.5 percent.

“This creates a headwind for a more substantive recovery in housing and the economy as a whole,” said economist Diane Swonk of Mesirow Financial of the slowing foreclosure pipeline.

Housing seems to be ceding the once-crucial role it played in the U.S. economy.

In the second quarter of 2010, it accounted for 15.3 percent of the country’s gross domestic product, down from 18.5 percent at its peak in 2005, according to the National Association of Home Builders.

While the sector could once be counted on to lead the nation out of recessions, that too has changed, said Karl Case, co-creator of the Case-Shiller home price index.

And now all 50 U.S. states have started a joint investigation of the mortgage industry

The result of all the halted foreclosures, both explicit and unofficial, is a de facto national moratorium, said Guy Cecala, publisher of Inside Mortgage Finance, an industry newsletter.

“We have the traditional holiday foreclosure moratorium coming up so if this just drags on for another month or so, it will be January” before bank repossessions start happening again, Cecala said.

Last year, mortgage finance giants Fannie Mae and Freddie Mac asked mortgage servicers, the banks who collect loan payments even if they don’t own the loans, to take a breather on foreclosures during the holiday season.

NO URGENCY

In the very short term, the pileup of properties that had been moving through the foreclosure process could help home prices slightly because it means less supply.

That is especially the case in the original bubble markets of Florida, California, Arizona and Nevada where foreclosures are thickest on the ground, said IHS Global Insight economist Patrick Newport.

“It’s a potential short-run positive for home sales,” said independent housing economist Tom Lawler. “But it’s highly unlikely that this is a longer-run positive.”

Indeed, if the spike in foreclosures on lenders’ books causes them to dump properties on the market, home prices could drop 20 percent, said Newport.

IHS Global Insight has already forecast a decline of between 8 percent and 10 percent for 2011.

That forecast was based on an assumption that banks would continue following an implicit policy of cushioning home prices by releasing foreclosure inventory gradually, Newport said.

A hit to home prices will cause consumers to feel still poorer, and to restrain spending accordingly, Newport said.

Consumer spending accounts for two-thirds of the American economy.

Home prices could fall even further in the markets hardest-hit by the foreclosure crisis, said homebuilding industry analyst Joel Locker of FBN Securities.

He could see prices dropping as much as 30 percent along the coast in California.

GIMME CREDIT

Foreclosure sales already make up 34 percent of home sales, according to foreclosure data and sales website RealtyTrac.

Many prospective buyers would likely sit on the sidelines until any moratorium is lifted lest prices fall further, which means home sales could fall as well, said John Burns, who runs an real estate consulting firm in Irvine, California.

“We’re already seeing consumers saying there’s no urgency to buy today, that mortgage rates will be the same in the spring. Home prices might be even cheaper by then,” he said.

Lenders’ errors in foreclosure processing will come back to hurt them in more ways than one, Lawler said.

Investors dumped bank stocks on Thursday and Friday amid fears their profits could be hit by the growing crisis.

FBR analyst Paul Miller estimates related losses could range from $6 billion to $10 billion for the banking industry.

The banking industry could handle such losses, but if the process of investigating and cleaning up lenders’ flawed foreclosure procedures take longer than anticipated, that number could rise, IHS GLobal Insight’s Newport said.

In the second quarter, U.S. banks’ total loans and leases were down 3 percent to $7.395 trillion, according to FDIC data.

If banks suffer bigger losses, they will have to bulk up their reserves, which will make them even less inclined to lend than they already are, Newport said.

Reporting by Corbett B. Daly in Washington and Helen Chernikoff in New York

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