Is a Foreclosure Bubble Growing? Taking a Look at the Facts

by Simon Lindsay on Foreclosure Crisis

We’ve discussed previously the fact that a lot of potential foreclosures – over one million – were due to be filed in 2011 but weren’t because of delays in foreclosure processes. There is also a lot of talk in the industry about how these foreclosures will impact the market once they are filed and placed on the market.

All of the introspection and discussion has led to one question: Is there a foreclosure bubble growing in the market, just like the real estate bubble that burst in 2007 and dropped the market off of a cliff?

The definition of a bubble is a rapid expansion or valuation in prices to an unsustainable level. Often these bubbles are not really fueled by anything tangible, such as economic improvement; we found, for example, that the 2007 crash was fueled by real estate prices that rose with no real reason why other than people expected them to and bid accordingly.

So, how can we define a foreclosure bubble? In some ways, it is a reverse bubble – or, less like a bubble and more like a mechanical spring. When you depressed a spring, it stays down only as long as you exert pressure on it. When you take your hand off, the spring naturally recoils back up.

Or, to use another example, it is like building a dam on a river. The dam stops the water from flowing, but only for so long – eventually, unless you do something about it, the water builds up and eventually bursts the dam. Dams have sluice gates that help control the pressure behind the wall. In this market, sluice gates are foreclosure auctions – but if foreclosures don’t make it onto the market through filings, they can’t be sold, and no pressure is relieved.

Foreclosure filings were on a tear for three years, until the latter half of 2010. Since then, filings are down dramatically – as much as 35.1% on average across the nation from this time last year. As we’ve stated, this decrease is not due to systemic improvement in the economy. Foreclosure filings haven’t fallen because fewer people are defaulting; they’re being frozen because banks have been extremely reluctant to process them because of the foreclosure fraud scandals that have swept the industry.

This freeze – or building of the dam, or compression of the spring, or whatever metaphor you choose – is also due to loan modification programs, mandatory counseling, and other initiatives designed to help homeowners stave off foreclosure. This has added to the delay in foreclosure processing and has slowed the speed at which foreclosures are processed, sold, and purchased.

All of these factors have culminated in over a million foreclosures waiting in the background, due to be unleashed on the market over the next 12-18 months.

It appears that a reverse bubble is growing, and when it pops, home prices are sure to reach the bottom we’ve all been waiting for over the past five years. That’s good news eventually for homeowners, ironically, since it would at least indicate the beginning of the end of the long slide in home prices. It’s even better news for homebuyers and investors, who could reap enormous profits from rock-bottom prices and a wide swath of available foreclosures to purchase.