When banks pulled back on foreclosures two years ago following a government investigation into faulty paperwork by lenders, Wall Street analysts, academics, and researchers thought the lull would be followed by a storm. They believed that once banks resolved the claims of delinquent homeowners piling up in courts and worked through their backlog of foreclosures, tens of thousands of houses would hit the market, driving down prices for years to come.
It never happened—even after the five biggest U.S. mortgage servicers reached a $25 billion settlement with federal and state regulators in February. Instead, the number of residential properties for sale in the U.S. shrank to the lowest level in a decade, while prices have appreciated at the fastest pace since 2005. An index of pending home resales compiled by the National Association of Realtors climbed 5.2 percent in October, the most recent month for which data are available. The median price of an existing home sold in October jumped 11 percent from a year earlier, to $178,600, the steepest annual increase since November 2005, according to the group. “Many of us, myself included, feared a wave of foreclosures when the settlement came,” says Susan Wachter, professor of real estate and finance at the University of Pennsylvania’s Wharton School. “I was wrong.”
One reason she and her fellow real estate watchers got it wrong was that in the wake of the settlement, banks were compelled to cut more deals with strapped homeowners. Since March, the five largest U.S. mortgage servicers provided loan relief to 309,385 borrowers, according to a Nov. 19 report by Joseph Smith, who heads the independent office established to monitor compliance with the settlement. Almost 22,000 borrowers had principal forgiveness totaling $2.55 billion. And 113,000 borrowers won bank approval for short sales, yielding another $13.1 billion in principal writedowns.
Federal government loan-modification programs are also gaining traction as the economy improves and fewer reworked loans re-default. Record low interest rates have triggered a spike in mortgage refinancings, which has helped homeowners stay current on their loans by lowering monthly payments. At the same time, institutional investors including Blackstone Group (BX) and Colony Capital have been purchasing thousands of foreclosed homes in bulk before they even hit the market and then renting the properties out instead of reselling them. The Federal Reserve Bank of New York had estimated that as many as 1.8 million properties would be taken back by banks in 2012. Yet through October, there have been only about 559,000 home seizures, according to RealtyTrac.
“In hindsight, by delaying and prolonging the foreclosure process, that gave the market time to stabilize and get back on its feet,” says Daren Blomquist, vice president of RealtyTrac, which warned a year ago that huge numbers of foreclosed homes were going to hit the market. “Maybe bureaucracy is actually helping, in this case, to diffuse the impact of the foreclosures. Talk about unintended consequences.”
In Stockton, Calif., one of the U.S. cities hit hardest by the housing crisis, the number of homes for sale fell 42 percent in October from a year earlier, thanks in part to a 21 percent decline in foreclosure filings over the same period. Listings routinely attract multiple offers, and prices are on the rise. “We don’t have enough homes now to meet the needs of the market,” says Paul Jacobson, a Stockton native and real estate broker for 22 years, as he cruises the city’s northern fringe, where suburbia meets farmland. “People see a foreclosed home for sale in this area and they’re going to jump on it.”
Stockton resident William Hoeurn last month secured a $337,906 principal reduction on his mortgage from Bank of America (BAC), shrinking monthly payments on his three-bedroom house to $884 from $2,362. The 66-year-old teaching assistant fell behind on his loan payments after his wife lost her job and two of his grown children, who helped pay the mortgage, moved out. “Before, I was having bad dreams that I am losing my house,” says Hoeurn, a refugee from Cambodia. “Now, I feel very happy.”
It still may be a little early to pronounce the housing slump over. Almost a quarter of all U.S. homeowners with a mortgage owe more than their homes are worth, making them candidates for future defaults. Robert Shiller, an economics professor at Yale University and co-creator of the S&P Case-Shiller home price indexes, believes the inventory of potential foreclosures remains a threat across the U.S., especially if the economy slows. “It’s funny how people have so much confidence in the recovery. History shows that these markets are hard to predict.”