Worse is yet to come in housing crisis

HOME FORECLOSURES hit record levels in 2007--and there's a lot worse to come.

That's the view of both homeowners' advocates and Wall Street companies, based on the upward spike in foreclosures last year and falling home prices that will leave some homeowners paying mortgages that cost far more than their houses are worth.

According to the company RealtyTrac, an online marketer of foreclosure properties, 2.2 million foreclosure filings were reported in 2007, a 75 percent increase over 2006. The trend, moreover, is for the worse, with foreclosures in December 2007 nearly doubling over the number in December 2006.

Many of these foreclosures were those with sub-prime loans--mortgages with high interest rates to begin with, or adjustable rates that ballooned beyond the buyers' ability to pay.

But, says economist Dean Baker, "We are just seeing the beginning of the crisis."

"There are a lot of people with little or no equity in their homes, who owe more on their mortgage than what the house is worth--for example, people who paid $300,000 on a house that's now worth $250,000," said Baker, co-director of the Center for Economic and Policy Research.

Baker pointed to a report by the National Association of Realtors showing that in 2006, more than 40 percent of homebuyers financed the entire purchase of their homes--that is, paid no down-payment.

Now, of course, house prices are falling--a drop of 8.4 percent in November over the same period a year ago, according to the S&P Case/Schiller housing price index. In some localities, the drop is much more severe. As Baker pointed out in a recent article, home prices in San Diego are dropping at a 27 percent annual rate. In Los Angeles, the rate of decline is 24.7 percent, and in San Francisco, 22.2 percent.

The Wall Street firm Merrill Lynch predicts further declines, forecasting an average drop of 15 percent in housing prices in 2008, another 10 percent decline next year, and a probable further decline in 2010.

The result, said Baker, will be a major hit to the economy as lenders are forced to take over homes and market them at fire-sale prices. "If home prices go back to their historic trend line, that's an $8 trillion decline," he said. "Even if it goes only halfway back to the trend, that's still $4 trillion," which will lead to higher losses for banks.

ALREADY, FORECLOSURE ghost towns dot the U.S. These include gentrifying neighborhoods like Baltimore's Reservoir Hill, where construction has virtually ceased and houses are abandoned--to entire California towns like Stockton, Bakersfield and Fontana, where low prices lured buyers from San Francisco and Los Angeles willing to endure long commutes for the sake of an affordable home.

Now, as prices drop, even mansions in upscale Las Vegas suburbs sit empty, abandoned by owners no longer able to pay. Meanwhile, banks are dumping the houses for rock-bottom prices, undercutting the value of surrounding homes. For example, Hudson & Marshall, which calls itself "America's largest foreclosed real estate auction firm," will auction about 250 Los Angeles-area foreclosure houses February 9 and 10.

Even the head-in-the-sand economic forecasters in the Bush administration acknowledge the wider economic impact of the housing crisis. "It now appears that the effects of the housing slump on real [gross domestic product] growth will persist into 2008, holding down growth and delaying the expected rebound in activity," the administration stated in its newly released budget document.

The foreclosure crisis was predicted several years ago by analysts at the Center for Responsible Lending (CLR), which estimated in late 2006 that 2.2 million homes would go into default. "At the time that report came out, the mortgage bankers and a lot of others said, 'You're screaming bloody murder, saying the sky is falling and it's not true,'" said Kathleen Day, a spokesperson for CRL. "Now, everyone's caught up to our estimates, or exceeded them."

The CRL, a nonprofit aimed at exposing predatory lending practices and fostering community development, also contends that both the government and lending industry plans to help borrowers are far from what's needed.

"I support the [Treasury Secretary Henry] Paulson plan if it helps anybody, but it only helps a tiny number of people," said Day of the government program to freeze interest rates for people with adjustable-rate mortgages. The program excludes anyone who's been late with a mortgage payment or is in foreclosure already, among other restrictions.

There's even less help forthcoming from the lending industry. According to CRL research, in the third quarter of 2007, mortgage lenders initiated foreclosures seven times more often than they modified mortgages, and 13 times more frequently than they modified sub-prime mortgages. The CRL also found that just 118,200 homeowners were likely to get loan modifications under Paulson's Treasury Department plan.

Day cites market impediments to a comprehensive aid package to restructure loans--for example, disputes between holders of securities tied to the loans and incentives for mortgage-servicing companies that make more money when they foreclose on a property than when they restructure a loan.

The CRL's own recommendation is a modification of federal bankruptcy law to allow judges to alter terms of a loan, the same way they can in any other contract--but the industry has so far resisted this.

The lenders' pursuit of their narrow self-interest and political obstacles will likely exacerbate the crisis. Day summed up the CRL's perspective: "We think it's going to get a lot worse before it gets better."