Banks Aren’t Foreclosing

Due in part to various foreclosure moratoriums and also just a plain logistical backlog, a curious thing is taking place. While the number of mortgages that are seriously delinquent has been soaring, the rate of actual foreclosure repossessions is only creeping up.

Nationally, according to First American Core Logic, a big title insurance firm, the repossession rate was 0.7% in May — up from 0.6% a year ago. At the same time the number of mortgages that are more than 90 days past due has increased to 6.5% of all mortgages — up from 4.0% in May of 2008.

It is said that California leads the country, so this article from the L.A. Times may show where the rest of the country is headed. There, the repossession rate is actually down to 1.0% from 1.1% a year ago. At the same time, the serious delinquency rate (90+ days) has soared to 9.5% from 5.0% a year ago.

In other words, the consequences for not paying your mortgage have gone down. For many people it is possible to live rent- and mortgage-free for over a year.

A big part of the problem could be just the logistical bottlenecks of handling so many foreclosures. As a bit of anecdotal evidence, a commentator on a blog I read regularly (Calculated Risk) who is a real estate lawyer in Florida, reports that a single judge in Miami has a docket of over 40,000 foreclosures. While that is not exactly an ironclad source, I have found her to be a reasonable person in the past, and have no real reason to doubt her.

The other part of the problem is that if the bank actually forecloses, there is no way that it can avoid recognizing the loss. By letting things slide, they can extend and pretend that eventually everything will get caught up. They also avoid the upkeep costs on the foreclosed property.

So in the short term, this non-foreclosure strategy can be beneficial to the banks like (but not limited to) Wells Fargo (WFC) and Bank of America (BAC), at least from an accounting perspective. Also, the house is less likely to be vandalized if the “owner” is still in it than if it is vacant.

It is also obviously beneficial to the non-paying homeowner, who now has significantly more available cash each month. Those that chose to take simple steps like demanding proof that the mortgage servicer has actual legal claim to the house (the paper work is often messed up) can delay the actual repossession even more.

The danger is that more and more people will end up going down that route. The cash flow to the banks and the holders of the mortgage backed securities is obviously hurt a great deal. This is creating a huge foreclosure backlog. Either all those 90+ day delinquent mortgages will be cured, or the number of actual repossessions will soon skyrocket. The final alternative is that a large portion of the population will be living rent-free indefinitely.

Of the three scenarios, the most likely one is that the rate of actual repossessions will start to pick up. Given the rising unemployment rate and the exceeding long length of unemployment in this recession, having large numbers of these delinquencies cured seems exceedingly unlikely. If the current situation keeps up with no consequences for not paying your mortgage, we could end up with an economy that looks sort of like a third-world country, where large numbers of people are effectively squatters with unclear titles to property (Hernando de Soto has written extensively on this in the case of Peru), which will eventually choke off the economy.

However, for the short term, if you are living in an underwater house and are having a hard time paying your mortgage, the last thing you want to do is mail in the keys and move out. That will hurt your credit almost as much as an actual foreclosure. Better to put the money aside and wait for the sheriff to show up at the door. He might be awhile in coming, and in the meantime, you live rent- and mortgage-free.

Not great advice for the economy as a whole, but for the individual it is probably the best course of action, provided you are likely to lose your house anyway. Eventually, that sheriff will show up, but in the meantime you will have improved your cash flow by thousands of dollars a month.

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