Potomac Divide Shows Court Foreclosures Delay a Recovery

The Maryland and Virginia suburbs of Washington are a lot alike, with similar populations of workers from the U.S. capital, incomes above the national average and unemployment rates below the norm.

Their housing markets are going in opposite directions.

Home prices rose 0.8 percent in Virginia last year while across the Potomac River in Maryland they fell 3.6 percent, according to data provider CoreLogic Inc. The reason is that Maryland, like 23 other states including New York and Florida, requires court approval to foreclose on delinquent homeowners, a lengthy process that has slowed comebacks across the country, said Thomas Lawler, a housing consultant and former chief economist for mortgage financier Fannie Mae.

“States that have dealt with foreclosures in an expeditious way, whether or not it’s good from a social perspective, appear to be recovering,” Lawler said in a telephone interview from his office in Leesburg, Virginia. “The difference is the foreclosure laws.”

The 24 so-called judicial states, which have about 42 percent of the 50.3 million U.S. residential mortgages, provide automatic court review of home seizures. That gives borrowers a legal forum to demand proof that lenders have the right to foreclose, or to argue for mortgage modifications -- while extending the process.

Without Court Intervention

In nonjudicial states, lenders send notices to delinquent borrowers and record defaults at the county level without court intervention. That has helped hard-hit states such as Nevada, Arizona and California reduce their foreclosure inventory quickly, paving the way for a rebound. For a recovery to take place, the supply of foreclosed properties, which usually sell for less than non-distressed homes nearby, must shrink before prices can find a floor.

“I don’t think the housing market finds its footing until we’ve worked through that mountain of property that’s still sitting out there in foreclosure,” said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania.

The backlog of foreclosures may start to clear following the $25 billion settlement, announced Feb. 9, with the five largest U.S. mortgage lenders. Home seizures fell sharply while attorneys general in 50 states investigated allegations that the banks used faulty or forged paperwork for repossessions, a practice known as robo-signing.

Stepping Up Foreclosures

The settlement won’t change the legal framework that sets the pace of repossessions, and may lengthen the timeline because it prohibits banks and loan servicers from paying incentives to “encourage speed in the signing” of seizure-related documents. Still, lenders are expected to step up foreclosures 25 percent this year and surpass the 2010 record of 1.05 million, according to property research firm RealtyTrac Inc.

While that will inflict pain on delinquent homeowners in the short run, it will make a long-term recovery more likely, Zandi said.

States with nonjudicial foreclosures “are seeing the backlog of foreclosures clear more rapidly,” Jay Brinkmann, chief economist for the Washington-based Mortgage Bankers Association, said today in a report on delinquencies. “In contrast, the percentage of loans in foreclosure in the judicial system states has hit an all-time high of 6.8 percent, almost two and a half times higher than rate for nonjudicial states.”

Judicial-State Increase

In judicial states, loans were delinquent for an average of two years before repossession, 40 percent longer than in nonjudicial states, according to Lender Processing Services Inc. The number of delinquent mortgages increased in 15 of the 24 judicial states last year while declining in 23 of the 26 nonjudicial states, according to the Jacksonville, Florida-based real estate services company.

“It would take less than three years at current rates to clear the inventory of loans in nonjudicial states,” said Herb Blecher, a senior vice president at the firm. “In judicial states, we’re looking at closer to eight.”

In Maryland, 13.4 percent of loans were delinquent or facing foreclosure in December, up 0.2 percentage points from a year earlier, according to Lender Processing Services. The Virginia delinquency rate was 8.3 percent, down 0.7 percentage points from 2010. The U.S. average rate was 12.3 percent, down 0.7 percentage points.

Milder Housing Bust

The Washington metropolitan area had a milder housing bust than battered states such as Florida, California, Nevada and Arizona because there was less overbuilding and fewer job losses around the capital. The unemployment rate was 6.2 percent in Virginia and 6.7 percent in Maryland in December, according to the U.S. Bureau of Labor Statistics. Nationally, the rate fell to 8.3 percent last month from 8.5 percent in December.

“Both markets worsened, but Virginia peaked and declined much earlier than Maryland, and it’s consistent across all counties for each state,” Sam Khater, senior economist for CoreLogic, said in an e-mail from his office in McLean, Virginia. “Given that the D.C. metro area serves as a control - - similar economies across the state border, similar housing market dynamics, etc. -- it’s interesting to note that foreclosure laws can make a difference at the local level.”

Two Counties

Fairfax County, Virginia, and Montgomery County, Maryland, have similar demographics and populations of about 1 million, both up more than 11 percent from a decade ago. The Fairfax County median household income was $105,416, compared with $93,373 in Montgomery County, according to U.S. Census data.

Fairfax County home prices ended last year at $387,000, up 26 percent from a post-peak low in January 2009, while the Montgomery County median was $335,000, a 12 percent increase from a bottom in January 2011, according to Metropolitan Regional Information Systems Inc., a listing company in Rockville, Maryland.

The recovery gap widens with distance from the center of Washington, said William Noel, a real estate broker with Re/Max Allegiance who is licensed in both states. The rebound has taken hold in northern Virginia, while southern Maryland is still hampered by foreclosures, he said.

Prince George’s County, Maryland, 20 miles (32 kilometers) southeast of Washington, and Prince William County, Virginia, 29 miles southwest of the capital, experienced similar building booms followed by foreclosure outbreaks, Khater said. Median home prices in Prince George’s fell 9 percent last year to $160,000 while Prince William dropped 0.6 percent to $238,500, according to Long & Foster Real Estate Inc. of Chantilly, Virginia.

‘Exactly the Same’

“The dirt and the land are exactly the same,” Noel said in a telephone interview from Woodbridge, Virginia. “Three or four years ago, there were ‘for sale’ signs all over here, because people were losing their homes. Now people see things improving. They’re feeling better and we’re seeing multiple offers.”

Florida, at 11.9 percent, had the highest rate of homes awaiting foreclosure as of Dec. 31, according to Santa Ana, California-based CoreLogic. Foreclosures bogged down there after September 2010, when banks imposed a moratorium amid the robo-signing scandal.

The state had the third-highest number of foreclosure filings in both 2009 and 2010, then fell to seventh last year, behind six nonjudicial states that are clearing their property gluts, according to RealtyTrac. The bank settlement probably will help unplug the real estate docket and return Florida to the top five by the end of the second quarter, said Daren Blomquist, spokesman for the Irvine, California-based firm.

Jump in Florida

Default filings in Florida jumped 36 percent last month from January 2011, the state’s first annual gain in more than a year, RealtyTrac reported today.

The effect of delayed distressed sales can be found in such places as the Fort Myers-Cape Coral area on Florida’s Gulf Coast, where the median single-family home price rose 36 percent last year to $123,400, according to the Florida Association of Realtors. Prices probably will fall again when the spigot reopens, said Marc Joseph, owner of a residential brokerage in Cape Coral.

“Things may look good, but in the back of my mind, I know there’s that backlog,” he said.

Pain before gain has been the rule in large swaths of California, a nonjudicial state that led the U.S. with the most foreclosure-related filings in 2011 and had eight of the 10 metro areas with the highest foreclosure rates, RealtyTrac said in its year-end summary.

Stockton Foreclosures

In Stockton, located in California’s Central Valley and home to more foreclosure filings per household than any city but Las Vegas, bank-owned and short-sale homes traded for an average 12 percent less than nondistressed properties in the third quarter. That’s down from a 24 percent differential two years earlier, when the distressed inventory was twice as big, the data seller said. Short sales are transactions in which the price is less than the amount owed.

Prices that were in free fall early in the crisis have stabilized, with a median of $74 a square foot in December, down 4.9 percent from year earlier, according to real estate data provider Zillow Inc.

“Our market has been pressed for so long, bank-owned sales are almost like a regular sale,” said John Morris, sales manager for broker PMZ Real Estate in Stockton.

Protection for Homeowners

Despite the speedier market recovery in nonjudicial states, some homeowner advocates argue that the protections offered in judicial states are necessary. Questionable bank behavior during the housing collapse shows the need for clear-cut avenues of redress, said Michael S. Barr, a law professor at the University of Michigan in Ann Arbor.

Judicial review is a needed protection that benefits individual borrowers, said Margery Golant, a homeowners’ attorney in Boca Raton, Florida. Lawyers in that state were among the first to bring the robo-signing allegations to light, leading to the probe by state attorneys general and settlement with companies including Bank of America Corp. and JPMorgan Chase & Co.

“When you don’t have a judicial officer involved, there’s nobody home,” Golant said in a telephone interview. “It’s just a mortgage company and its attorneys and nobody else. In a nonjudicial setting, it’s just totally robotic.”

New Nevada Law

Nevada, a nonjudicial state with the country’s highest foreclosure rate, is adding legal protections. A new law that took effect in October compels lenders to obtain notarized affidavits before homes can be seized. Legislators expect it to provide “transparency and legitimacy” after homeowner rights were “trampled,” said Nevada Assemblyman Marcus Conklin, a Democrat from Las Vegas.

“This law doesn’t stop foreclosure, but it does require proof that a trustee has the right to take action on a property,” Conklin, the Assembly majority leader who co-sponsored the legislation, said in a telephone interview.

The protections offered in judicial states may do little to help borrowers. Automatic court review has added time and cost to foreclosures without helping homeowners pay off, or “cure,” their loans, according to Paul Willen, senior economist at the Federal Reserve Bank of Boston, who analyzed 310,351 mortgages from 2000 to 2011 with Kristopher Gerardi, a fellow Fed economist, and Lauren Lambie-Hanson, a researcher.

No Borrower Upside

A year after default, 26 percent of delinquent loans had cured in judicial states, compared with 25.6 percent in nonjudicial states, the authors wrote in a December working paper. Mandated reviews in judicial states slowed the rate of foreclosure sales by more than half, with no upside to borrowers or markets, they said.

Previous academic studies suggest that the longer process also didn’t result in a greater likelihood of borrowers obtaining loan modifications, while it increased the chance they would choose so-called strategic defaults to stay in their homes for long periods without making any payments, Willen said.

“Delaying does not help borrowers, and extra time is not allowing them to cure,” he said in a telephone interview. “Judicial foreclosure appears to block efficient foreclosure without promoting efficient resolutions.”

Prolonging the foreclosure process will have one certain effect, according to Stan Humphries, chief economist for Seattle-based Zillow: It will delay a housing recovery.

“Pick your poison,” he said in a telephone interview. “Either rip the Band-Aid off now or do it slowly, in which case your market’s going to remain in the doldrums.”

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