With regard to mortgage losses, the housing market remains in a fascinating period of "extend and pretend," where it is clear that mortgage conditions are worsening, but we have not yet seen an explosion in foreclosures, or a movement of the growing inventory of foreclosed homes onto the open market. The main exception is Fannie Mae and Freddie Mac, which have been accelerating foreclosures in recent months, accompanied by a regular influx of funds from the U.S. Treasury (which already exceeds $145 billion) to bail out losses on what would otherwise be insolvent GSE debt.
The Lender Processing Services (LPS) June Mortgage Monitor provided the most recent report last week, noting that "foreclosure starts for loans owned by the Government Sponsored Entities (GSEs) are at an all-time high. The largest percentage of GSE foreclosure starts are coming from loans that are six or more months behind on payment. This finding is consistent with the reports of increased Home Affordable Modification Program (HAMP) trial period cancellations. Total delinquent and foreclosure inventories remain at historically elevated levels, with Jumbo and Agency prime product experiencing the greatest percentage increase since January 2008. The report also shows that two loans are deteriorating in status for every one loan that improved."
As James Saccacio, the CEO of RealtyTrac observed a week ago, "The roller coaster pattern of foreclosure activity over the past 12 months demonstrates that while the foreclosure problem is being managed on the surface, a massive number of distressed properties and underwater loans continues to sit just below the surface, threatening the fragile stability of the housing market."
On Sunday's edition of Meet the Press, Alan Greenspan remarked that there is a huge number of homes that would go "underwater" if home prices were to slip by another 5-7%, and that such an event could potentially trigger a large wave of additional foreclosures. I am not familiar enough with the price distribution of existing mortgages to contribute much insight here, but the remark does help to explain why banks appear so reluctant to bring the massive inventory of delinquent and foreclosed properties onto the market.
It is not clear precisely at what point the burgeoning inventory of foreclosures and delinquent mortgages will impact the markets, but it is clear that conditions are not improving, and that fresh economic weakness would tend to destabilize an already fragile situation. At the same time, it is not out of the question that we may be quietly allowing U.S. banks to go insolvent without disclosure, covering the losses over time out of wide interest spreads on existing loans, and that we may be able to avoid outward evidence of mortgage deterioration simply by allowing the Treasury to go further and further into deficit on behalf of the GSEs. Undoubtedly, all of this will produce future strains in the form of inflation risk, longer-term commodity price pressures, fiscal instability, stagnant lending activity, continued failure of smaller institutions, further loan writedowns, and other events.
