3 Possible Outcomes of the Widespread Foreclosure Delay

A number of big banks have halted foreclosures. Ally Financial (previously known as GMAC) and JPMorgan were a few of the first big names to state that there may be documentation issues with some defaulted mortgages they own or service. Since then, other banks and servicers have taken their lead and temporarily ceased foreclosing on properties as they investigate their processes and documentation. At this point, it's unclear precisely the effect this will have on the housing market, but here are three possibilities.

Further Harm to the Housing Market

Housing market sentiment is already quite low. Demand on the part of Americans to buy homes has been very anemic since the expiration of the buyer credit. But it's possible that this foreclosure delay could make matters even worse.

First, banks might feel forced to revamp their entire process for mortgage origination. If that happens, then it might create a time during which banks and servicers go through a transition period and new mortgages slow. That would make it even harder for Americans interested in buying a home to secure mortgages.

Some reports indicate that judges are ruling in favor of struggling homeowners in the sorts of situations that triggered the foreclosure delay. As a result, they're either providing them the home free and clear if the bank cannot prove ownership or forcing banks to modify the mortgages. If judges become increasingly more activist with these cases, then even larger losses on these mortgages for banks could result. That would likely force them to restrain lending further.

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Keep the Housing Market Stagnant

If there's anything that these foreclosure delays can definitely be said to cause, it's greater uncertainty. The delay will make it harder to know for sure if the housing market has hit the bottom. For some time, potential buyers won't know if home prices will continue to decline in the future, as a flood of pent up foreclosures could hit the market. Banks might also feel pressure to modify more mortgages, which would likely lead to more re-defaults.

Under this scenario, banks might be relatively unscathed so won't have to reduce credit to borrowers. Americans, however, will continue to feel wary about the housing market, so sales will remain low. This will result in the housing market settling into a limbo where it isn't really recovering, but it also isn't really deteriorating further.

Allow Time for Demand to Return

There is a possible advantage that these delays could provide to banks, however. We know that home buying has been especially weak over the past several months, since the credit expired. That means it's more likely that foreclosures could begin to add more homes to housing inventory as weak sales will have more trouble offsetting them. That would put downward pressure on prices. But if foreclosures slow due to delays, then this may allow inventory to stay constant for some months, providing buyer demand more time to recover from its post-credit hangover.

There are some who believe that banks have already been intentionally holding back defaulted homes in shadow inventory for precisely this reason. These foreclosure delays might simply make that practice even easier. If the strategy works as those banks hope, then prices won't fall as far. If it doesn't, however, then the market will still ultimately sink -- it will just take longer to hit bottom.

Of these potential outcomes, the first two are clearly bad for the broader economy. One of the reasons for the weaker consumer sentiment throughout the summer was the housing market's regression. If Americans see it continue to struggle, then the recovery will have trouble as well. The final possible outcome, however, could help a little if things turn out as the best-case scenario hopes. If home prices find lasting stability, then sentiment could improve.