California foreclosure blog

AP put out a story yesterday about "bidding wars" that are affecting home values in the greater Phoenix area. The article states that in several markets throughout the country, prices on bank-owned homes are being inflated by a combination of investors keen on getting a deal, regular home buyers (many of them first time buyers), but mainly by the fact that lenders are not putting homes on the market as fast as they are taking them back in foreclosure. The proof: for each of the last four months (March through June 2009), over 300,000 foreclosures were reported by RealtyTrac. That's over 1 million homes, on track for 3 million for the year. Lenders are currently the largest home sellers in the market, and they are taking back homes at an increasing rate. So the only real reason for the trickle in REOs coming to market is that lenders want things that way because it maximizes returns.

But there's another lender-controlled factor that is sure to make these mini-bubbles burst: lenders have manipulated not just the REO market by sitting on houses before offering them for resale, they are also waiting a very long time to even start foreclosure on homes in areas with severe value losses.

In my own neighborhood (I live in Solano County, California, an area that has been hard-hit by foreclosures), where home values have lost between 35 and 40 percent since the bubble burst, there are several homes that have been vacant for upwards of a year. Not only are these homes not on the resale market as REOs, some of them have not even been foreclosed on, because lenders appear to be dragging their feet in taking back certain properties. I have a client who lives in another hard-hit area in Solano County, and they have not made a loan payment in nearly a year, but the lender has not even started the foreclosure process.

This sort of lack of action begs the question: why would lenders act this way? I think the answer is simple. In my client's case, the home has lost over 2/3 of its value, and the note holder will lose hundreds of thousands of dollars the moment it becomes the owner of the property. What's more, the local market is still falling, even though lenders are holding back on putting more REOs up for resale, which would mean even greater losses to the investor who owns the loan.

So, the lenders are trying to gut it out by manipulating the supply of REOs, and even by extending the foreclosure process if they decide they could make more money by creating a mini-bubble market. After all, these same lenders will likely be asked to provide the loans to buyers in these markets, and higher sale prices lead to bigger loan fees and interest income.

So what's the risk of this lender market manipulation? Lenders cannot afford to hold off on foreclosing and reselling forever, for several reasons. Rising unemployment (estimates are that 60% of this year's foreclosures are due to job or income loss), the upcoming wave of foreclosures in commercial property (many large commercial properties are in foreclosure, with more on the way), and mounting reserve account balances (banks are required to set aside revenue in reserve accounts for bad loans) will all cause the "shadow inventory" dam to burst, probably within the next 9 to 12 months. And when that dam bursts, so will all the mini-bubbles out there, which will lead to another lender-created drop in property values and prolong the pain for real estate professionals, home builders, but most importantly for homeowners and communities.