David Streitfeld has an interesting article this morning in The New York Times discussing the outlook for an increase in the number of housing short sales and government efforts to facilitate these. A short sale is one in which the lender agrees to accept a sale price less than the outstanding mortgage balance.
Short sales can be advantageous to both mortgagor (borrower) and mortgagee (lender). The credit impairment for the borrower is less than for a foreclosure. The lender can often recover more of the outstanding debt than by going through foreclosure. Even if the sales prices are comparable, the short sale occurs much more quickly and with significantly less attendant expense than do foreclosures and subsequent resale.
I feel that the short sale enabling actions by the government have an advantage over other programs such as those aimed at mortgage modification to keep mortgagors in the homes. Mortgage modifications have at least two negative features:
* Many mods eventually default anyway, so modification programs are simply kicking the can down the road for many mortgagors involved.
* Market clearing price levels are not discovered in the modification process. Mods maintain an artificial price level for the modified properties.
Short sales have been a difficult option for many lenders for several reasons, some of which are given by Streifeld. Among these:
* Many lenders do not have personnel and processes in place to handle the labor intensive process.
* Many mortgages are serviced by one institution and owned by someone else, often through a MBS (mortgage backed security). This makes the decision process unduly complex.
* Second and third mortgages make the short sale very difficult.
* Lenders are reluctant to make loss recognition any earlier than they absolutely have to. Short sales recognize losses immediately while the foreclosure process extends recognition of losses, sometimes for one or more years.
A quote from the Streitfeld article reflects some of the above:
Taking effect on April 5, the program could encourage hundreds of thousands of delinquent borrowers who have not been rescued by the loan modification program to shed their houses through a process known as a short sale, in which property is sold for less than the balance of the mortgage. Lenders will be compelled to accept that arrangement, forgiving the difference between the market price of the property and what they are owed.
“We want to streamline and standardize the short sale process to make it much easier on the borrower and much easier on the lender,” said Seth Wheeler, a Treasury senior adviser.
The bottom line, though, is the number of delinquent borrows targeted. The quote mentions hundreds of thousands of delinquent borrowers. This could be only 10% +/- of the five million future foreclosures projected by many (including this author). If successful, this program will work at the margins. It is not going to be a market clearing action all by itself.
We can not expect to see a significant increase in new home sales until existing homes are selling at market clearing prices. An increase in short sales moves in that direction, but until millions of mortgage delinquencies are resolved, home builders can not have a healthy market. Several hundred thousand short sales will help, but as much as 90% of the delinquency problem will remain.
Disclosure: No positions.