A US house price washout

Barack Obama's foreclosure settlement with US banks may be intended to boost the property market, but more likely it will drag prices even lower as the banks resume repossessions.

US investors heaved a sigh of relief overnight, as the Obama administration unveiled a major $25 billion settlement with five major home lenders over foreclosure abuses that occurred after the housing bubble collapsed.

As part of the deal, the five banks involved – Ally Financial, Bank of America, Citigroup, J.P. Morgan Chase and Wells Fargo – have agreed to spend nearly $20 billion cutting the loan balances for borrowers that are at risk of foreclosure, and to refinance other borrowers who are keeping up with their loan repayments but who owe more than their homes are worth. They’ll also pay $5 billion in cash penalties to borrowers and to state and federal governments.

In exchange, officials promised to drop mortgage-related legal claims against the banks.

Although the Obama administration is hoping that the settlement will provide a much-needed boost for the flagging US property market in a presidential election year, critics are doubtful. They point out that the deal is only likely to benefit around one million home owners at a time when roughly one in four borrowers is "underwater” – they owe more on their mortgage than their home is worth. Altogether, an estimated 11 million US homeowners are more than $700 billion underwater on their loans.

What’s more, critics argue that the deal is extremely generous to the banks, because it removes a major litigation threat that has been overshadowing them since late 2010 when evidence first emerged that banks had resorted to illegal shortcuts when trying to repossess homes from delinquent borrowers. In order to speed up the foreclosure process, some bank employees failed to properly review the paperwork, and robo-signed thousands of foreclosure documents.

Indeed, critics argue that the deal could see US home prices, which have already slumped by around one-third from their peak, fall even further this year. The foreclosure process has been jammed since late 2010, when evidence of widespread robo-signing first emerged. But as a result of the latest deal, banks are now free to resume repossessing houses, which will flood the housing market with even more distressed sales, dragging US housing prices even lower.

Even more worrying, a surge in foreclosures could result in a major drain on US consumer spending, at a time when the outlook for US growth is faltering. Because legal problems have stopped banks from foreclosing on problem housing loans, millions of delinquent borrowers have been allowed to stay. They’ve effectively been "squatters”, remaining in their homes even though they’ve stopped paying their home loan repayments, and they’ve stopped paying rates and charges to local governments.

It’s estimated that there are up to 10 million squatters, who have been "saving” around $50 billion a year by not having to pay either rent or repayments. And the squatters have spent most of this $50 billion buying consumer products.

But with the banks now likely to step up their foreclosures, more and more squatters will find themselves being evicted from their homes, and forced to pay for rental accommodation. As a result, we could see consumer spending weaken even further in coming months.

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