Foreclosures to Climb before Settlement with Banks can Help

The $25 billion settlement with banks over foreclosure abuses may result in a wave of home seizures; inflicting short-term pain on delinquent U.S. borrowers while making a long-term housing recovery more likely. Lenders slowed the pace of foreclosures as they negotiate the $25 billion settlement. With an agreement reached, banks are likely to resume property seizures.

A surge of home seizures may drive down values, at least for a while, in a fragile market. The number of new foreclosure filings fell 34 percent last year. And, it resulted in a backlog that now may flood the market with low-cost properties. This will result in more foreclosures in the short term because some of the foreclosures that should have happened last year are instead going to happen this year. But the price decline should be modest as the banks will be sensitive to market prices.

Home prices have dropped 33 percent from their July 2006 peak. About 11 million homeowners have negative equity. This has limited their ability to sell or refinance and reduced the incentive to keep paying. Principal reductions may help cut the number of mortgage delinquencies by improving borrowers’ finances and reducing incentives for strategic default. But because homeowners have $750 billion in negative equity in the US, the deal will help the market very little. However, it may have an added benefit of testing the effectiveness of principal forgiveness in preventing defaults. If successful, it may spur a larger-scale program.

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