The woes of the troubled US housing market have just increased following a decision by the highest court in Massachusetts which will likely make it more difficult for banks to foreclose on delinquent home loans.

On Friday, the Supreme Judicial Court of Massachusetts upheld a lower court’s decision to void foreclosure sales conducted by two major US lenders, Wells Fargo and US Bancorp.

The cases dated back to 2007 when Wells Fargo and US Bancorp began foreclosure proceedings against delinquent borrowers on two separate properties. Since neither borrower fought the proceedings, the banks were able to quickly take control of the two properties.

But the banks hit problems when they tried to get a judgment from the state’s land court that would give them clear title to the properties. In 2009, the court rejected the banks’ arguments, saying they had not been assigned the mortgages before they foreclosed. Instead, the banks only acquired the mortgages after they commenced foreclosure proceedings.

The case centred on the process used for transferring loans after they were made. When individual loans were sold to an investor, the new owner’s name was often left blank in loan document in order to minimise paperwork hassles. Frequently, loans would change hands several times before being bundled together with other loans into a mortgage-backed security.

Both mortgages in the Massachusetts case had been bundled into securities and sold to investors. The two banks that foreclosed on the borrowers were acting as trustees on behalf of investors in the trust.

The Massachusetts Supreme Court ruled that since neither bank had proved it had a right to evict the borrowers, the foreclosures would be voided, and ownership of the properties was returned to the borrowers.

If the Massachusetts ruling is worrying for banks because it is likely to delay some foreclosures, making it harder for banks to claw back their loan losses by selling homes that they’ve repossessed.

The banks in the case had asked the Massachusetts court to restrict its ruling to new foreclosures. The court declined to do so, which means that the banks could face new claims from foreclosure cases that they thought were completed.

In recent months, US banks, which are facing intense scrutiny from regulators, have become more reluctant to seize homes from distressed borrowers. But according to a recent report by the Federal Reserve Bank of Dallas, foreclosure delays are likely to exacerbate problems in the US housing market.

The report — entitled The Fallacy of a Pain-Free Path to a Healthy Housing Market — points out that real US house prices have tumbled by 33 per cent since their peak in August 2006. But, it warns “home prices must fall a further 23 per cent before they revert to their long-term mean.”

The report notes that sales of new homes have fallen sharply since the Obama administration’s home-purchase tax credit expired last April. As a result, new home inventories — which have slumped to 42-year low — still represent a 8.6-month supply. The report says that typically a balanced market has an inventory supply of five to six months, and home prices tend to decline until that level is achieved.

The report says that one problem facing the new home market is the massive overhang of existing homes for sale:

“The 3.9 million homes listed in October represent a 10.5-month supply. One in five mortgage holders owes more than the home is worth, an impediment that could hinder refinancings in the next year, when a fresh wave of adjustable-rate mortgages is due to reset. The number of listed homes, in other words, is at risk of growing further. This so-called shadow inventory incorporates mortgages at high risk of default; adding these to the total implies at least a two-year supply.”

According to the report, a further 3.6 million homes and units — or 2.7 per cent of US housing stock — are vacant and being held off the market. The Dallas report says that presumably many of these properties are included six million distressed properties that are listed as 60 days delinquent, in foreclosure or foreclosed in banks’ inventories.

The Dallas Fed report says that delays in foreclosures could temporarily arrest housing price declines, but it will only cause the supply of distressed properties to increase over time. Even worse, it could cause banks to shy away from making home loans because they’re worried about the underlying value of the property.

It concludes that with nearly half of all bank assets backed by real estate, both home owners and the banking system are deeply concerned about further home price declines. But, it warns there is “no perfect solution to the housing crisis exists. The latest price declines will undoubtedly cause more economic dislocation. As the crisis enters its fifth year, uncertainty is as prevalent as ever and continues to hinder a more robust economic recovery.”

*This article was originally published on Business Spectator

Peter Fray

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