The Huge Risks Holding Back Housing

Housing has come a long way since the peak of the financial crisis in 2008 and 2009. But has the market bottomed yet?

I recently saw someone put that question to U.S. Housing and Urban Development Secretary Sean Donovan at a Bloomberg Washington Summit. Here's what he had to say:

My view is that we've reached a turning point. Families facing foreclosure are in half. The Fed Housing Index is up. Sales are up. Credit availability is up. And we've begun to see a different view in the market. Having said that, three critical barriers remain to a fuller recovery. We still have to lower number of families falling into foreclosure, deal with shadow inventory, and credit availability.

I think this is a pretty crisp summary of the issues. Although the number of foreclosures is down, we still have 4.2 million houses in either the foreclosure process or serious delinquency. One thing that's important to understand is that since 2009, the majority of foreclosures haven't been on subprime mortgages, but they are closely tied to local unemployment rates. In other words, those facing foreclosure today are largely responsible borrowers who just got caught up in a tough economy. A better job market could really help them stay in their homes.

All these foreclosures have resulted in an extra "shadow" supply of homes between 1.6 million and 10 million (depending on how you want to calculate the number of houses that haven't hit the market). The numbers are exacerbated by enormous conflicts of interest in the mortgage servicing industry. For example, today the bulk of mortgages have been securitized by and are managed by companies that don't actually own them. Bank of America (NYSE: BAC  ) , Wells Fargo, and JPMorgan, therefore, may choose not to modify mortgages on properties where they're the owners of a second lien. In those instances, borrowers lose their homes, and lenders lose their investments because the bank doesn't want to record today a loss that it will take eventually.

If homeowners were able to take advantage of historically low interest rates to refinance, that would reduce their debt burdens and speed up the recovery. In fact, that's one of the major ways the Fed ordinarily helps us get out of recessions. We've seen the Dow (INDEX: ^DJI  ) rally repeatedly over the past few years when the Fed announced it's going to try to bring down interest rates.

But because banks are somewhat reluctant to extend credit, and many mortgages are underwater, a lot of homeowners are having trouble refinancing. That has actually been a major boon to mortgage investors like Annaly Capital (NYSE: NLY  ) , Chimera (NYSE: CIM  ) , and American Capital Agency (Nasdaq: AGNC  ) , which get to lock in higher interest income from borrowers. However, it's been a drag on the economy. The administration has been taking some steps to free up credit for refinancing and encourage mortgage modifications, but it will take a lot to get traction, given how far home prices have fallen.

So has the housing market hit bottom? It well may have. But that doesn't mean national average prices are going to soar anytime soon.

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Ilan Moscovitz doesn't own shares of any company mentioned. You can follow him on Twitter @TMFDada. The Motley Fool owns shares of JPMorgan Chase, Annaly Capital Management, and Bank of America. The Fool owns shares of and has created a covered strangle position in Wells Fargo. Motley Fool newsletter services have recommended buying shares of Wells Fargo and Annaly Capital Management. The Motley Fool has a disclosure policy.

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