The relative severity of two factors—unemployment and falling home prices—are likely to determine how many foreclosures cascade onto the housing market between now and 2010.
But just how many is the question on many people's minds. During a teleconference this morning, a team from Citigroup’s Citi Investment Research gave its cautionary assessment of the foreclosure dilemma and potential scenarios, based on different economic and housing factors.
Citigroup has a major stake in this issue, as it owns about 1.5 million mortgages with a balance of $175 billion and services another 5 million mortgages totaling $600 billion that have been securitized. Last month, Citigroup announced a six-month program to reach out to 500,000 high-risk borrowers who are current on their payments but someday may require loan modifications to stay in their homes.
Overall, since homeowners started defaulting on their mortgages in unusually high numbers last year, lenders have foreclosed on 1.3 million loans and have put another 2.2 million loans through the process.
Rahul Parulekar, head of Citi’s Mortgage-Backed Securities and Real Estate Asset-Backed Securities Research unit, estimates that another 6.5 million loans will enter foreclosure by 2010 if home prices fall by another 15 percent and the unemployment rate hits 7.1 percent.
If the economy worsens, with prices dropping 20 percent and unemployment rising to 9 percent, foreclosures during this period could reach 8 million, according to Citigroup's forecast.
Parulekar projects that half of the foreclosures, in either scenario, would occur by the end of 2009. However, he also points out that only about 40 percent of distressed option adjustable-rate mortgages (ARM) would lapse into foreclosure by 2010, with more occurring in 2011 and beyond. “The real stress will come in 2010, when option ARMs are recast,” he states, meaning that the size of the loan exceeds an 115 to 120 percent loan-to-value ratio and borrowers must start paying on a higher loan balance.
Citi bases its estimates on an econometric model that is subject to several variables, not the least of which being how aggressively the federal government intervenes to encourage, or even mandate, loan modifications, notes Robert A. Young, Citi’s director of mortgage credit modeling. He and Parulekar observe that the government’s efforts so far—which include the FHASecure and Hope for Homeowners programs—have been mostly ineffective, in part because they are limited in scope or have not resolved investor issues about the contractual legality of loan modifications that reduce the principal of a securitized mortgage.
Young favors slowing down foreclosures by lowering mortgage interest rates, although he acknowledges that any reduction that only helps distressed borrowers will be less palatable politically to taxpayers. Neither Young nor Parulekar is enthusiastic about some of the other solutions that have emerged, including blanket moratoriums on foreclosures, which some states are enforcing. “It can be done, but a blanket moratorium without doing anything else is only going to worsen the losses for holders and could extend home price depreciation longer,” they say.
However, both think that a “cramdown” solution, where the government forces all parties—borrowers, lenders and investors—to accept loan modifications that include lower principals (and, therefore, lower returns), could be on the horizon. Just the palpable threat of it, says Parulekar, “could lead to a lot more principal forgiveness.”
John Caulfield is senior editor at BUILDER magazine.