As Banks Foreclose More Aggressively, Home Prices May Suffer

Will their game of taking on more and more inventory be sustainable as demand dries up?

For some time now, banks have been slowly taking on more inventory of defaulted residential properties. Their strategy has been to slowly release them into the market, in the hopes that prices would stabilize. But as time wears on, it becomes clear that buyers aren't going to sustain the demand needed to keep up this game, as foreclosures come in at high numbers and mortgage modification programs struggle. This may have the effect of banks feeling forced to drive down prices in the months to come.

A Wall Street Journal article on this topic today provides the following chart. It shows pretty clearly that as distressed sales occur, prices suffer:

prices stress sale chart wsj.gif

In particular, check out the shaded regions. When fire sales ramp up, prices decline.

As the article notes, banks are more likely to concede lower prices than homeowners, who might feel more sentimental and financial attachment to their home and fight for a higher price. Banks, however, have neither the time nor resources to be bothered worrying about keeping prices a little higher. So if they are increasingly feeling pressure to reduce their inventory, they will likely have to do so at lower prices.

The question is really how long banks can manage to allow their inventory of foreclosures to rise and sit on their books without liquidating. If they can do so indefinitely, then prices might remain artificially higher, and demand could finally catch back up in several months to a year. But if they need to sell, and it becomes a buyers' market due to too much supply, then prices should begin to drop again.