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Increased Foreclosures: An Equal and Opposite Reaction

Posted by Larry Doyle on April 15, 2009 11:53 AM |

There are tremendous cross currents in residential housing. Over the course of the last few months we have seen the following:

-an uptick in housing starts
-an uptick in new home sales
-a decline in home prices as indicated by the S&P/Case-Shiller Index

Do not forget, though, that Uncle Sam had Freddie Mac and Fannie Mae postpone the foreclosure process over the course of the last few months. Additionally, Congress compelled certain of the larger mortgage originators, such as JP Morgan Chase, Citi, and Wells Fargo, to also postpone foreclosures.

While the postponing of foreclosures allows for a delay in that process, regrettably it does not negate it. As the WSJ reports today, Banks Ramp Up Foreclosures.

The Federal Reserve knows that increased supply in housing in the face of rising unemployment will further depress home prices. In fact, just yesterday the Fed made a statement indicating it believes housing prices may overshoot to the downside much as they overshot to the upside earlier this decade. That scenario seems to be the equivalent of a physics principle – for every action, there is an equal and opposite reaction.

The subsequent impact of this increased foreclosure activity is an increase in chargeoffs by banks holding the mortgages. While certain banks, such as Wells Fargo, reported surprisingly strong 1st quarter earnings, be mindful that many analysts criticized Wells for not reserving more against future chargeoffs.

Over and above this impact on bank earnings, do not forget that the model used for the Bank Stress Tests incorporated an unemployment rate of 10.3% as the absolute worst case scenario.

That rate is now commonly accepted as a very strong likelihood.


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