John F. Wasik
September 15, 2008

Sept. 15 (Bloomberg) — The government rescue of hobbled U.S. mortgage giants Fannie Mae and Freddie Mac last week was like treating a compound fracture with a Band-Aid.

While the initial market reaction was lower mortgage rates for the least-risky loans — which will attract some new home buyers and refinancers — it will do little to alleviate the spillover penalty that foreclosures are inflicting on homeowners and communities.

Some 40 million homes in communities that are hardest hit stand to lose $202 billion in equity as foreclosures cause collateral damage to adjacent homes, according to the Center for Responsible Lending, a Durham, North Carolina-based nonprofit that focuses on consumer-credit issues.

The conventional wisdom about the foreclosure tsunami is that the free market will eventually resolve the problem. Buyers will then swoop in and buy properties when prices sink to a certain level, perhaps 20 percent to 25 percent less than peaks in 2006. Voila! Excess inventory — an 11-month supply of unsold homes — will be cleared and the housing market will rebound.

Yet those who employ that thinking ignore some key social variables. Foreclosures depress prices in entire neighborhoods or towns for years. The lower valuations then slash assessments for property taxes, resulting in pared revenue for schools and other public agencies. Those who are foreclosed upon have ruined credit and can’t refinance.

The spillover penalty begs a question that has yet to be answered: Who would want to buy in a community where homes are boarded up; the tax base is depleted; and public services are so underfunded that they have to cut programs or raise levies?

New Foreclosure Study

As foreclosures accelerated to the fastest pace in three decades in the second quarter, a triple whammy of bank repossessions, falling home prices and the inability of property owners to sell makes the U.S. real-estate situation even uglier for potential investors in the most troubled areas.

In a recent study of bank-owned properties from 2007 through the first half of 2008 in the Chicago area, the Woodstock Institute found that property investors are largely avoiding foreclosure auctions. The institute is a Chicago-based non-profit that promotes community reinvestment and economic development.

Only 6 percent of the properties in the Chicago area that had been foreclosed upon, acquired and auctioned by banks in their study period had been bought by investors, the report found, compared with almost 30 percent three years ago.

That means a huge inventory of properties remained in the hands of banks, in this case more than 22,000 homes.

Costs to Communities

Foreclosures cost communities dearly in services and lost tax revenue.

Homeowners in foreclosure typically aren’t paying taxes, and banks are reluctant to maintain properties. Unable to afford down payments or security deposits for leases, untold numbers of families are becoming homeless.

The most imperiled areas were ravaged by subprime lending for those with below-average credit ratings. Minority communities were hardest hit.

Empty homes translate into lower neighborhood house values, estimated to be reduced by 0.9 percent to 1.8 percent for each home in a neighborhood hurt by foreclosures, the Woodstock Institute says. On a $400,000 home, that’s a loss of as much as $7,200 for each home in the surrounding community.

Gauge Risk

If you decide that the housing market is nearing a bottom, as many suggest, you have to consider some critical gauges:

— What’s the collateral risk of the market you are buying in? This is the probability of losing equity. The Detroit and Grand Rapids, Michigan areas; Akron and Cleveland, Ohio; Bakersfield, Modesto, Riverside-San Bernardino and Stockton, California; and Memphis, Tennessee, were the riskiest markets from Feb. 8 to July 8, according to San Juan Capistrano, California-based, which tracks housing- market safety.

— Buying a distressed property? You need to price it properly by subtracting the inflated appreciation of the bubble years. Assume a modest rate of return of about 3 percent since 2000, which is near the average for consumer inflation.

— What if you’re facing foreclosure? Contact the Neighborhood Assistance Corporation of America and inquire about their “Home Save” program.

Rather than accept the fractured reasoning that the market will somehow repair the housing crisis on its own, a new policy that keeps people in their homes makes more sense.

Grijalva Plan

If a homebuyer can’t afford a mortgage, why not turn them into a renter? One such proposal by U.S. Representative Raul Grijalva, an Arizona Democrat, would let people stay in their homes by altering foreclosure rules.

Under the Grijalva plan, homeowners would pay fair-market rent for as long as 20 years, provided they bought their homes for less than the median price for the area.

Another approach is to force lenders to offer loan modifications that would write down the equity for owner-occupied homes to current market value and lower monthly payments.

Meanwhile, will the $200 billion the U.S. Treasury says it may invest in Fannie and Freddie make a difference?

In the interim, it’s buoyed the credit markets somewhat. Congress will still need to weigh in with another round of bailout legislation. What we have seen is only a minor triage leading to more major surgery and therapy.

To contact the writer of this column: John F. Wasik in Chicago at

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