Foreclosures Forever?

John Carney has an interesting take on some likely repercussions from the foreclosure mess. Basically, he thinks that it’s going to be a lot harder for banks to work through the foreclosure process from this point on.

Carney points out that the courts and judges are going to be a lot more skeptical as they review foreclosure actions and that the attorneys representing homeowners are likely to be far more aggressive in contesting foreclosures. The outcome might still be that the banks get their security back but it might take a lot longer to get to that result. He also suggests that there might well be another development that we didn’t expect.

Borrowers are also emboldened. For as long as anyone can remember, borrowers who had stopped paying their mortgages rarely contested foreclosures. They may have been broken hearted to lose their homes, but they generally went along with the process that took their home away.

That easy compliance may be coming to an end. The perception that banks have been acting dishonestly in foreclosures has broken the trust of borrowers. It has also given birth to the hope that some homes may be kept out of foreclosure even after a default.

“This is as close to a populist uprising as I’ve ever seen,” one attorney who represents a regional bank in the southwest told me.

He explained that some people who once may have been strategic defaulters—willing to lose their homes when the value dropped below the amount owed on it—are now become “strategic resisters.” They stop paying their mortgage, stay in their homes, and fight the bank in court—all the while basically living rent-free.

The strategic resister is still an outlier, according to most of the people involved with foreclosures who I spoke with. But they are growing in numbers.

It might be an outlier now but if Carney is right and the foreclosure process ends up being spread over years it won’t stay that way. The doomsday scenario has always been that homeowners with negative equity but still able to pay their mortgages would just throw in the towel and walk. So far this hasn’t happened but if homeowners think they can count on years with no mortgage payment the math might push them over the line. If you have a mortgage payment of a couple of grand a month, two, three or four years of banking it starts to look pretty attractive and it isn’t hard to restart your life with that kind of money in the bank after you finally lose the home.

Throw in the possibility, slight though it may be, that some defect will come to light that let’s you keep the house debt free and more than a few people will opt to play that lottery.

I do see one obstacle to strategic resistance. The exclusion from tax liability for debt forgiven on one’s principal residence expires in 2012. If it isn’t extended then any gain from not paying the bank might be lost to the tax man. Do you extend it to help the homeowner who has no hope of keeping his residence and thus allow others to game the system or do you sacrifice a few in order to bring about some closure?

If  Carney is right, and I see no reason to suppose otherwise, then we’re going to be living with a dysfunctional housing market for a lot of years. One more reason to be somewhat pessimistic about the prospects for the overall economy. Just what we need.

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