Is the Foreclosure Crisis Real?

Know anyone dealing with foreclosure right now? You may—if you live in the Midwest, or in overheated real estate markets like California, Florida, Nevada, and Arizona. The rest of you are probably wondering what all the fuss is about.

Here's something to confuse you further: On Thursday, June 14, the Mortgage Bankers Assn. announced that the delinquency rate for mortgage loans on residential properties fell 11 basis points in the first quarter of 2007, to 4.84%, from 4.95% in the fourth quarter of 2006.

In the same period, the percentage of outstanding loans in the foreclosure process (not included in the delinquency rate) rose 9 basis points, to 1.28%. The rate of loans entering the foreclosure process increased four basis points, to 0.58%. True, this is a record high. But is it as high as you thought?
A Big Crisis in a Few States

The outlook for the housing market seems to get worse with each passing day, and the flames of panic are being fanned by reports of skyrocketing foreclosure rates and stories of desperate homeowners. On June 12, the yield on the 10-year Treasury note hit a five-year record high of 5.265%, sending stocks plummeting and aggravating fears about rising mortgage rates. The same day, Irvine (Calif.)-based RealtyTrac reported that foreclosure activity shot up 19% in May from April. But RealtyTrac's list of the states with the highest foreclosure rates in May was little changed from April or March, suggesting that the foreclosure crisis is limited to certain areas.

"The bulk of the country is not in this circumstance," says MBA Chief Economist Douglas Duncan. And the bulk of the mortgage market, he says, is "very healthy." The MBA attributes most of the first-quarter increase in foreclosure starts to a boost in activity in California, Florida, Arizona, and Nevada. "Without these four states, foreclosure starts would have declined," Duncan predicts. In fact, 24 U.S. states saw a decline in foreclosure starts, while the rest of the states saw what the MBA describes as "negligible" increases.

For total foreclosure inventory for the quarter (1.28% of all loans) the blame fell on Ohio, Indiana, and Michigan. These three states account for just 8.7% of all mortgages in the county, according to the MBA, but they account for 19.9% of the total loans in foreclosure and 15% of all the foreclosures started in the first three months of 2007. Without these three states, Duncan predicts that the portion of loans in foreclosure in the U.S. would be 1.12%—below the 1.19% average of the last 10 years.
Soured Speculators and Subprime Borrowers

In the first quarter, foreclosure starts increased 19 basis points in Nevada, 13 basis points in Florida, 12 basis points in California, and 7 basis points in Arizona, according to the MBA. These areas have been heavily influenced by speculators who drove up home prices in the first part of the decade. Now that home prices have started to fall, the MBA says these investors are walking away from properties, especially as they face resets for the adjustable rate mortgages they took out for the homes. Homeowners in Florida are also facing higher insurance bills, the association says.

As for the worsening problems in the subprime market, well, that's Nevada, Florida, California, and Arizona's fault, too. The rate of foreclosures started on subprime ARMs jumped to 3.23% from 2.7% in the first quarter of the year, but 26 states had decreases in subprime foreclosure starts, according to the MBA. Again, Duncan says the national rate would have decreased were it not for the increases in those four states.

In Ohio, Indiana, and Michigan, problems with late payments and defaults extend across all loan types, according to the MBA survey. Sluggish income growth and job loss are the culprits here; all three states have suffered declines in manufacturing employment. Duncan notes that Michigan has lost nearly 300,000 jobs since 2001—more than the number of current jobs in Wyoming.
Recovery Predicted for Late in 2007

Though high foreclosure rates are largely confined to the seven states highlighted in the MBA survey, foreclosure is still a very real and serious problem for the country, says Moody's Economy.com's Pat McPherron. "The idea that there's a hump and we've passed it, that everything's fine and it's just these states that are having trouble—I'm not ready to buy into that," he says, citing higher gas prices and rising interest rates.

McPherron suspects that the reason delinquencies fell in the first quarter may have to do with a change in the loans that MBA members serviced in that period. Eighty subprime lenders have gone out of business since late 2006, the MBA estimates, and others including Accredited Home Lenders (LEND) and Fremont General (FMT) have stopped making the risky loans.

But even with the first-quarter decrease in delinquencies, the MBA expects to see a "modest increase" in late payments over the next two quarters, with an increase in foreclosures on a lag. The association expects the housing market to recover in late 2007.

"I don't feel that the problem has been bypassed yet," says McPherron. "I think it's still pending, and it's going to get worse."

Indeed, the foreclosure situation could get much uglier in states like Nevada, Florida, California, Arizona, Ohio, Michigan, and Indiana. But the rest of the country might not notice.

Click here to see the 10 U.S. states with the highest foreclosure rates.