| The housing market has taken another leg down as potential homebuyers remain on the sidelines and inventory swells. This widening imbalance should push prices lower in the near term. Clearly the market is vulnerable, which means we should pay attention to the brewing foreclosure problems. |
| As we have been arguing for some time, the main risk to the housing market comes from the massive foreclosure overhang. The main concern has been that if the foreclosure process speeds up, distressed properties will flood the market, creating an even greater disequilibrium in the market. Unfortunately, we now have another reason to worry. Attorneys general nationwide have launched a joint investigation into the foreclosure process on allegations that banks used “robo-signers” (sign documents without ensuring accurate information). Banks have put foreclosure moratoriums in place to examine their foreclosure processes. |
| This foreclosure probe should lead lenders to review policies and cure deficiencies, which could be a clean and simple process. Under this best case scenario, the effect on the housing market would be negligible. In fact, it could be positive in the short term, since moratoriums will temporarily reduce inventory of distressed homes, thereby supporting home prices. But this is clearly transitory. |
| The foreclosure probe could open the door to more litigation. Most notably, if a foreclosure is deemed to be improper, the title could be reinstated to the prior owner, and whoever bought the home out of foreclosure could lose title. This could have a ripple effect on title insurers. In addition, involving the courts could result in a wholesale re-evaluation of the foreclosure process. |
| This could seriously hurt confidence. If potential buyers of foreclosures doubt the legality of the foreclosure process, they will be hesitant to purchase. This means it will be even more difficult to clear distressed inventory, further depressing sales and prices. Confidence could suffer for some time simply from fear of this worst case scenario materializing. |
| In our view, the most likely outcome is somewhere between these two extreme scenarios. The foreclosure process is likely to be dragged out further, prolonging the weakness in the housing market, consistent with a painful U-shaped recovery. However, we admit that there is a heightened risk of a more dismal scenario. If negative momentum in the housing market kicks in, and feeds into the banking system and broader economy, it will be hard to fight.
Merrill Lynch Morning Market Memo 10/14/10 |
