Foreclosures stymie efforts to revive economy

John W. Schoen Senior producer • Profile • E-mail

More than two years year after the housing market tanked and the foreclosure rate began rising, the ongoing wave of distressed home sales is weighing on house prices and crimping a long-awaited economic recovery.

On Wednesday, President Obama signed off on the government's latest response to the crisis, a whittled-down bill aimed at helping millions of struggling borrowers keep their homes. But the latest effort may not be strong enough to reverse the downward spiral that has gripped the housing market and the economy.

After months of debate, the final version of the latest bill eliminated a key provision that would have allowed bankruptcy judges to modify mortgage terms. Faced with heavy pressure from the banking industry, Congress again tabled the highly contentious provision after several attempts to introduce it over the past year. That leaves the decision to refinance a mortgage up to lenders and investors holding securities backed by those loans.

Meanwhile, homeowners stuck with unaffordable payments, or who now owe more than their house is worth, must slog through the red tape of negotiating a new loan with their lender.

Courtney Scott, 60, a retired nurse living in Atlanta, has been trying for over a year to get her loan modified.

“This has just been round and round,” she said. “Every time we do what they say they need us to do, something happens where we need to resubmit it or they say there’s a backlog and it’s going to take more time.”

That backlog is growing as the pace of foreclosures rise. They're up 32 percent in April from a year ago, according to the real estate data firm RealtyTrac. Some 2.4 million new home foreclosures are expected this year, according to the Center on Responsible Lending. Nearly one in five homeowners is already “underwater” — owing more on their mortgage than their home is worth, according Moody’s. While pace of job losses has begun to slow, unemployment is still headed higher.

“You mix all of that together, and the foreclosure problem is getting worse not better,” said Mark Zandi, chief economist at Moody’s Economy.com. “We’re counting on the president's loan modification plan to really kick in here. But it hasn't yet, and we need to see it.”

Meanwhile, the rise in foreclosures is tearing a hole in the household budgets of those that lose their homes and those who live next door. As homes are sold off at distressed prices, the value of neighboring homes also drops.

Though home sales have perked up this spring, in some markets as many as half of those are distressed sales to new home buyers and investors looking for bargains.

“We need the foreclosure supply to start slowing down,” said Susan Wachter, a real estate professor at the Wharton School of Business. “As we get more homes through the foreclosure process, housing prices continue to fall.”

The government’s foreclosure relief effort is beginning to show signs of progress. The Making Home Affordable program, for example, gives cash incentives to lenders who provide foreclosure relief. In the first two months, some 55,000 homeowners were offered more affordable terms, according to the Treasury.

“We’re encouraged but we are not by any stretch convinced,” said John Taylor, president of the National Community Reinvestment Coalition, which has been working with Congress on various foreclosure relief proposals.

Since the foreclosure rate began rising in the middle of 2006, the government has made several attempts to slow the ongoing erosion of homeownership. In October 2007, the Bush administration launched the Hope Now Alliance, a public-private partnership designed to encourage lenders to rewrite loan terms to make payments more affordable.

Though the group says nearly a million mortgages were reworked, many of those "workouts" simply added missed payments to the outstanding principal, raised the monthly payment and made the new loan even less afforadble. As a result, more than half of homeowners who got help defaulted on their new loans in less than a year.

The latest effort centers on providing incentives to loan servicers — the companies who collect payments from homeowners on behalf of investors who jointly own the mortgage — to provide more affordable terms. The Making Home Affordable program, for example, offers incentives to lenders who lower monthly payments by either reducing the interest rate or stretching out the term to 40 years. The program applies to loans issued or sold to investors through Freddie Mac or Fannie Mae and the Treasury estimates it could help as many as five million homeowners.

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