Ever since the housing collapse began, market seers have warned of a coming wave of foreclosures that would make the already heightened activity look like a trickle.
The dam would break when moratoriums ended, teaser rates expired, modifications failed and banks finally trained the army of specialists needed to process the volume.
But the flood hasn't happened. The simple reason is that servicers are not initiating or processing foreclosures at the pace they could be.
By postponing the date at which they lock in losses, banks and other investors positioned themselves to benefit from the slow mending of the real estate market. But now industry executives are questioning whether delaying foreclosures — a strategy contrary to the industry adage that "the first loss is the best loss" — is about to backfire. With home prices expected to fall as much as 10% further, the refusal to foreclose quickly on and sell distressed homes at inventory-clearing prices may be contributing to the stall of the overall market seen in July sales data. It also may increase the likelihood of more strategic defaults.
It is becoming harder to blame legal or logistical bottlenecks, foreclosure analysts said.
"All the excuses have been used up. This is blatant," said Sean O'Toole, CEO of ForeclosureRadar.com, a Discovery Bay, Calif., company that has been documenting the slowdown in Western markets.
Banks have filed fewer notices of default so far this year in California, the nation's biggest real estate market, than they did 2009 or 2008, according to data gathered by the company.
Foreclosure default notices are now at their lowest level since the second quarter of 2007, when the percentage of seriously delinquent loans in the state was one-sixth what it is now.
New data from LPS Applied Analytics in Jacksonville, Fla., suggests that the backlog is no longer worsening nationally — but foreclosures are not at the levels needed to clear existing inventory.
The simple explanation is that banks are averse to realizing losses on foreclosures, experts said.
"We can't have 11% of Californians delinquent and so few foreclosures if regulators are actually forcing banks to clean assets off their books," O'Toole said.
Officially, of course, this problem shouldn't exist. Accounting rules mandate that banks set aside reserves covering the full amount of their anticipated losses on nonperforming loans, so sales should do no additional harm to balance sheets.
Within the last two quarters, many companies have even begun taking reserve releases based on more bullish assumptions about the value of distressed properties.
Now there is widespread reluctance to test those valuations, an indication that banks either fear they have insufficient or are gambling for a broad housing recovery that experts increasingly say is not coming.
Banks did not choose the strategy on their own.
With the exception of a spike in foreclosure activity that peaked in early-to-mid 2009, after various industry and government moratoriums ended and the Treasury Department released guidelines for the Home Affordable Modification Program, no stage of the process has returned to pre-September 2008 levels. That is when the Treasury unveiled the Troubled Asset Relief Program and promised to help financial institutions avoid liquidating assets at panic-driven prices. The Financial Accounting Standards Board and other authorities followed suit with fair-value dispensations.
These changes made it easier to avoid fire-sale marks — and less attractive to foreclose on bad assets and unload them at market clearing prices. In California, ForeclosureRadar data shows, the volume of foreclosure filings has never returned to the levels they had reached before government intervention gave servicers breathing room.
Some servicing executives acknowledged that stalling on foreclosures will cause worse pain in the future — and that the reckoning may be almost here.
"The industry as a whole got into a panic mode and was worried about all these loans going into foreclosure and driving prices down, so they got all these programs, started Hamp and internal mods and short sales," said John Marecki, vice president of East Coast foreclosure operations for Prommis Solutions, an Atlanta company that provides foreclosure processing services. Until recently, he was senior vice president of default administration at Flagstar Bank in Troy, Mich. "Now they're looking at this, how they held off and they're getting to the point where maybe they made a mistake in that realm," Marecki said.
Moreover, Fannie Mae and Freddie Mac have increased foreclosures in the past two months on borrowers that failed to get permanent loan modifications from the government, according to data from LPS. If the GSEs' share of foreclosures is increasing, that implies foreclosure activity by other market participants is even less robust than the aggregate.
"The math doesn't bode well for what is ultimately going to occur on the real estate market," said Herb Blecher, a vice president at LPS. "You start asking yourself the question when you look at these numbers whether we are fixing the problem or delaying the inevitable."
Blecher said the increase in foreclosure starts by the GSEs "is nowhere near" what is needed to clear through the shadow inventory of 4.5 million loans that were 90 days delinquent or in foreclosure as of July 31.
LPS nationwide data on foreclosure starts reflects the holdup: Though the GSEs have gotten faster since the first quarter, portfolio and private investors have actually slowed.
"What we're seeing is things are starting to move through the system but the inflows and outflows are not clearing the inventory yet," he said.
Delayed foreclosures might be good news for delinquent borrowers, but it comes at a high price.
Stagnant foreclosures likely contributed to the abysmal July home sales, since banks are putting fewer homes for sale at market-clearing prices.
Moreover, Freddie says a good 14% of homes that are seriously delinquent are vacant. In such circumstances, eventual recovery values rapidly deteriorate.
Defaulted borrowers were spending an average of 469 days in their home after ceasing to make payments as of July 31, so the financial attraction of strategic defaults increases.
One possible way banks are dealing with that last threat is through what O'Toole calls "foreclosure roulette," in which banks maintain a large pool of borrowers in foreclosure but foreclose on a small number at random.
O'Toole said the resulting confusion would make it harder for borrowers to evaluate the costs and benefits of defaulting and fan fears that foreclosure was imminent.