Foreclosure Pipeline Is Full to Bursting

The foreclosure pipeline will be full for years to come. That precludes any "recovery" in housing valuations as supply will swamp demand.

Last August, I wrote a story for AOL/Daily Finance titled Housing bottom premature. The clue? Foreclosure pipeline full. The backlog of distressed mortgages has only grown larger since then.

As Mish noted, Foreclosure activity hit a record in the first quarter of 2010.

According to realtytrac.com, foreclosure filings — default notices, scheduled auctions and bank repossessions — were reported on 932,234 properties in the first quarter, a 7 percent increase from the previous quarter and a 16 percent increase from the first quarter of 2009.

Meanwhile, the heavily hyped Federal program to stave off defaults via massaging the terms of mortgages is failing spectacularly: Defaults Rise in Loan Modification Program.

According to this New York Times article, about seven million households are behind on their mortgage payments. As I noted here yesterday, there are about 51 million mortgages in the U.S., so that means about 14% of all mortgage holders are in some stage of default. About 1 million are already in the foreclosure pipeline (as noted above) while a pool of 6 million defaulted/delinquent mortgages awaits entry into the pipeline.

While the numbers are imprecise, media reports suggest about one-quarter of all mortgage holders are "underwater," meaning that their homes are worth less than their mortgages balances.

As this chart illustrates, negative equity (owing more than the house is worth, hence negative equity) drives foreclosures.

If 25% of mortgage holders are underwater, and 14% are delinquent/in default, then we can expect the number of defaulted mortgages to rise as negative-equity homeowners throw in the towel and stop paying their mortgages.

Rising foreclosures, falling home valuations and increasing defaults form a positive feedback loop. Rising foreclosures pressure home valuations as hundreds of thousands of homes come to market. This decline in valuations increases the negative equity of mortgage holders who are already underwater, and pushes more owners into the negative equity pool where most will eventually capitulate and default on their mortgages. Thisincreases the pool of mortgages in the foreclosure pipeline, insuring more homes will be dumped onto the market in the future, and so on.

Anyone who sees a rising pool of millions of delinquent mortgages as the foundation of a recovery in housing valuations isn't considering the feedback loop which is now firmly in place.