What Was the Foreclosure Crisis?
The foreclosure crisis was a period of drastically elevated property seizures in the U.S. housing market between 2007 and 2010. The foreclosure crisis was one aspect of the financial crisis and Great Recession that developed during this period. The excessive extension of mortgage credit, complicated schemes of mortgage debt securitization, and rapid increase in the number of foreclosures (in an industry ill-prepared to process them all) each contributed to the crisis.
- The foreclosure crisis was a period of drastically elevated property seizures in the U.S. housing market between 2007 and 2010.
- Prior to and during the crisis, mortgage servicing companies processed large numbers of loans without adequate review of the information accompanying them.
- This messy process sometimes led banks to foreclose on the wrong property, miscalculate home values, and, in some cases, give lawyers for homeowners facing foreclosure the chance to throw the case out entirely.
- Excessive credit expansion during the housing boom, mortgage debt securitization, and a financial system unprepared to cope with a widespread increase in defaults all contributed to the crisis.
Understanding the Foreclosure Crisis
Foreclosure is the legal process that occurs when a homeowner fails to make full principal and interest payments on his or her mortgage. If this issue is not rectified within a specified grace period, the lender has the right to evict the homeowner, take control of the property, and then sell it off.
The foreclosure crisis peaked in Sept. 2010, when approximately 120,000 homes were repossessed in a one-month period. However, its roots lay in a downturn in the housing market that began early in 2007 and blossomed into a crisis when Lehman Brothers declared bankruptcy in Sept. 2008.
Excess Mortgage Credit
Excessively low interest rates due to expansionary monetary policy at the U.S. Federal Reserve, coupled with pro-housing policy by the executive branch, in the 2000s created a boom in home buying and the extension of credit for home mortgages. This led to generally sketchy or nonexistent oversight of underwriting processes as commission-hungry lenders recklessly dished out hordes of riskier subprime mortgages on sometimes predatory terms to people with low income and creditworthiness. This process was facilitated by the innovation of mortgage debt securitization that allowed lenders to pass the risks of these loans on to investors and continue lending.
The volume of mortgage debt relative to the economy's ability to repay rose rapidly. Total mortgage debt in the U.S. surpassed U.S. Gross Domestic Product (GDP) beginning in the 1st quarter 2008. Previously this ratio (total mortgage debt to GDP) had ranged between about 30% to 60% for most of the 20th century.
Mortgage banks frequently pocketed fees and then promptly sold the loans on to often inattentive financial institutions, which failed to do appropriate due diligence on the loans. The mortgages were securitized into Mortgage-Backed Securities and more complex instruments, which were believed at the time to be an adequate tool to manage the default risk of any one mortgage by combining it with other loans to effectively pool the risk and then distribute it across all holders of the issued security.
In addition to not ultimately being an adequate risk management tool (particularly when virtually all home prices fell and defaults became widespread) the securitization of the loans in many cases obscured the links between who held the loans and the borrowers.
Increase in Foreclosures
As the Federal Reserve began to hit the monetary brakes and slow down the massive flow of credit expansion in 2006, problems started to become visible in the industry. Tighter credit conditions made it harder for lenders to continue to extend risky mortgages and made existing mortgages with adjustable interest rates less affordable for existing borrowers. Between 2006 and 2008, delinquency rates on home loans more than doubled and would continue to climb through 2010 as the crisis spread.
When defaults rose, banks suddenly found themselves facing so many foreclosure events that they could not process them efficiently. Prior to and during the crisis, mortgage servicing companies processed large numbers of loans without adequate review of the information accompanying them. It was generally believed that defaults on home loans and the subsequent foreclosures would be individual or at most local events, which could easily be processed and liquidated in the course of lenders' and loan servicers' normal operations.
Hasty securitization during the housing boom had, in many cases, led to poor record-keeping of the actual ownership of any given mortgage loan. In some cases, banks failed to initiate foreclosures on homes for months after homeowners had ceased to make payments. Record-keeping processes had become so sloppy that banks could not always be sure they actually owned mortgages for properties being foreclosed, and even in some cases foreclosed on mortgage loans that they did not legally own.
Many bank employees simply signed everything that came across their desks, assuming all paperwork to be legitimate. Once the volume of foreclosures rose significantly, robo-signers created significant problems when they signed off on improper paperwork, either because they had no idea what they were signing or because they had to process far too many documents to do the proper work to authenticate them.
Employees that signed off foreclosure documents without reviewing them properly became known as robo-signers.
The effects of inaccurate and obscure paperwork combined with a run-up in the number of home loans going into default nationwide created widespread problems. Some banks foreclosed on the wrong properties, miscalculated home values, or, in some cases, gave lawyers for homeowners facing foreclosure the chance to throw foreclosure cases out entirely.
Resolution of the Foreclosure Crisis
In 2009, the government eventually reached a settlement with the nation's five largest mortgage servicers:
- Ally (formerly known as GMAC)
- Bank of America
- JPMorgan Chase
- Wells Fargo
The agreement, known as the National Mortgage Settlement, cost the servicers over $50 billion in penalties and consumer relief payments.
Affected borrowers received principal reductions or refinances for underwater loans, allowing them to avoid foreclosure and stay in their homes. In addition, the settlement required an overhaul of the loan servicing systems overseen by the banks.
Borrowers who lost homes due to foreclosure by these banks in states party to the settlement agreement became eligible for payments of approximately $1,480. The total settlement pay-out amounted to roughly $1.5 billion.
Real estate information company RealtyTrac estimated that one out of every 248 households in the U.S. received a foreclosure notice in Sept. 2012.