Why Obama's Housing Rescue Hasn't Prevented Record Foreclosures

After taking withering criticism for the Department-of-Motor-Vehicles pace of its initial efforts to keep struggling borrowers out of foreclosure, the Obama administration proudly announced last week that it had hit its goal of 500,000 trial loan modifications almost a month ahead of schedule. But with the foreclosure rate hitting a new record in the third quarter, the government's ability to put a meaningful dent in the tally of housing-crisis victims faces renewed skepticism.

Foreclosure filings were reported on 937,840 homes in the three-month period, a 23 percent jump from a year earlier, according to a report real estate firm RealtyTrac released Thursday. Home foreclosures in September, meanwhile, decreased 4 percent from August but remained 29 percent higher than a year earlier. "REO activity increased from the previous quarter in all but two states and the District of Columbia, indicating that lenders may be starting to work through some of the pent-up foreclosure inventory caused by legislative delays, loan modification efforts, and high volumes of distressed properties," RealtyTrac CEO James Saccacio said in a press release. Here's a look at why home foreclosures continue to break records even in the face of the Obama administration's expansive efforts to prevent them.

[See Why Do Home Foreclosures Keep Rising? 6 Things You Need to Know.]

1. Initial foreclosure wave: Borrowers who overleveraged themselves—through exotic mortgage products like subprime or adjustable-rate home loans—played a central role in the foreclosure crisis when it first picked up steam. But as the housing crisis rumbles forward, lenders have witnessed a significant shift in the types of mortgages going delinquent. For example, the Mortgage Bankers Association's most recent National Delinquency survey, released in late August, found that although "the rate of new foreclosures started was essentially unchanged from last quarter's record high, there was a major drop in foreclosures on subprime ARM loans. The drop, however, was offset by increases in the foreclosure rates on the other types of loans, with prime fixed-rate loans having the biggest increase."

2. Current foreclosure crisis: Mounting mortgage delinquencies for borrowers with good credit is a key indication that the labor market—rather than resetting loans—is the most significant force behind the foreclosure crisis we see today. "Keep in mind that most of the foreclosures we saw a year ago [occurred] when the unemployment rate was 5 percent, so really the first wave of foreclosures were driven by subprime loans [and] resetting loans," says Guy Cecala, publisher of Inside Mortgage Finance. Today, however, a national unemployment rate of nearly 10 percent is triggering "a whole new wave" of homeowners going into foreclosures on account of job losses, Cecala says.

[See Obama's Loan Modification Plan: 7 Things You Need to Know.]

3. Fighting the last war: The Obama administration announced in mid-February a sweeping effort to stabilize the housing market. A central plank was a $75 billion initiative to reduce monthly mortgage payments for as many as 4 million struggling homeowners through so-called mortgage modifications. But in order to obtain a mortgage modification, borrowers need an income stream, Cecala says. In a report released October 9, the congressional oversight panel monitoring the rescue suggested that the administration might be fighting the last war. "[The administration's mortgage modification program] was not designed to address foreclosures caused by unemployment, which now appears to be a central cause of nonpayment," the panel said in its report. "The foreclosure crisis has moved beyond subprime mortgages and into the prime mortgage market. It increasingly appears that [the program] is targeted at the housing crisis as it existed six months ago, rather than as it exists right now." In addition, foreclosure starts are occurring at more than twice the rate that trial modifications are extended, and there is no guarantee that homeowners won't simply redefault on their restructured mortgage, the panel said in the report.

4. Modified impact: Still, the administration's efforts are not without impact. "Originally, the expectations were that loan modifications were going to stop foreclosures and reduce the rate, and we would see immediate results. That was obviously wishful thinking," Cecala says. "Now we are of the belief that they are going to do absolutely nothing. The truth is somewhere in between." Celia Chen, the director of housing economics at Moody's Economy.com, expects that the program will modify around 1.5 million mortgages over the next three years. "That's a substantial number," she says. However, "even with those modifications, we expect that the number of foreclosure sales that will occur for this year will be around 1.9 million, and next year will just be a tad shy of that." (Chen is projecting roughly 1.8 million foreclosure sales in 2010.)

[See Principal Write-Downs Make for Better Loan Modifications—but Nobody Does It.]

5. Predicting the peak: Cecala says the unemployment rate will have to peak before we can expect to see a meaningful and sustainable reduction in the number of home foreclosures. In its 2010 economic forecast, the MBA projected that the unemployment rate would peak at 10.2 percent in the second quarter of next year. For that reason, Cecala expects home foreclosures to let up sometime in the middle of 2010. "We certainly have enough bad loans in the system . . . to keep foreclosures at record levels going through the first half of next year," he says. "So maybe a year from now we will see some letup, but we are not sure."