Will Massachusetts Mortgage Ruling Boost House Prices?

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Many foreclosures sales are on hold (Robert Galbraith/REUTERS)

A number of market watchers and housing analysts are saying that a recent real estate ruling by the Massachusetts Supreme Court could be a big boon for the housing market. While the ruling may reduce the number of houses for sale for the next few months, it’s not clear that it would boost housing prices. Here’s why:

On Friday, the Massachusetts Supreme Court ruled in two separate cases that banks have to have proof that they own a house before starting a foreclosure. In the past, banks were allowed to start the eviction process, and often even finish it, even if they didn’t have all the paperwork on hand that proved they, or their investors, owned the house. Only after the bank was challenged did it have to produce evidence that it had the right to foreclose.

Sounds obvious, but for banks it’s a big deal. At the height of the real estate boom, mortgages were bought and sold by banks often into trusts owned by thousands of investors. In many cases, the paperwork that detailed those transactions was sloppy. Sometimes it was lost or destroyed. The result is that many banks don’t have the documents readily on hand to prove they own a house. If pushed, most can establish that they have the right to foreclose. But that’s a costly process, so mostly banks have been trying to only produce that paperwork when pushed after foreclosures have already been filed. The Massachusetts ruling, if followed around the country, will force banks to have all the documentation on every foreclosure before the process is started, or risk not being able to foreclose. The rising number of foreclosures has dramatically slowed the time it takes a bank to repossess a house from little over eight months to nearly a year and a half. The Mass ruling could dramatically slow foreclosures further.

As a result, some real estate analysts and pundits are saying this is great news for the housing market. Fewer foreclosures means there will be fewer houses for sale. And less inventory should cause housing prices to rise. At least that’s how the NY Times reported it:

Reducing foreclosures in a meaningful way would act to stabilize the housing market, real estate experts say, letting the administration patch up one of the economy’s most persistently troubled sectors. Fewer foreclosures means that buyers pay more for the ones that do come to market, which strengthens overall home prices and builds consumer confidence in housing.

Felix Salmon, the blogger at Reuters, agrees:

Consumer confidence is a key factor in the health of the housing market and there’s an obvious connection from lower supply to higher prices, to higher confidence in housing as an asset class. That confidence might well turn out to be misplaced, of course. But a warm occupied home is a much happier thing, economically speaking, than a cold and empty one, even if the occupiers haven’t made a mortgage payment in years. Foreclosures carry a large economic cost and all things being equal, the less of them there are the better.

My problem with Salmon and the NY Time’s logic is that the inventory of foreclosed homes is not disappearing, it’s just going to be delayed. It’s very different. So while home buyers may temporarily have fewer houses to currently choose from, they will know that more houses–the shadow inventory–at lower prices, are likely to be available soon. Sellers know this as well. So it will take away the leverage they have to raise houses. Homebuyers may be more willing to pass knowing there could be better deals down the road.

Ed Leamer of the UCLA Forecast, like me, is skeptical of this idea that a policy of “pretend and extend” will somehow boost the housing market. He points out that sales have started rising again in California, where there are fewer foreclosures challenged in court, than in Florida, in which foreclosures have to be approved by judges, and take much longer. Quicker foreclosures have lead to a healthier market. And if banks have been able to survive foreclosures in the nation’s largest and once hottest housing market, why not elsewhere. Leamer says delaying foreclosures is worse. Banks will not start lending again until they know the full extent of their losses in the housing market. And bank credit, and getting the housing market off government life support, is key to restoring rising prices, or at least not falling ones. What’s more, foreclosure times have been rising all year, and more dramatically recently. Yet, housing prices continue to fall. So if there is a benefit of delaying foreclosures, we haven’t seen it yet.

The question is what is more damaging to the housing market, inventory or uncertainty? To believe that the foreclosure mess is good for prices you have to believe that house buyers will bid up the prices of properties knowing that they are likely to come crashing down again. In a market filled with flippers that can happen. But I suspect most people buying houses these days are expecting they will be there for a while.

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