Economic Impact of Foreclosure Crisis

As a result of easy credit, expectations of continued appreciation and low rates, subprime and exotic lending saw explosive growth in 2004 and 2005 — leading to a real estate bubble, according to the study from the U.S. Conference of Mayors announced today. In addition, lending on home equity lines-of-credit was exploited.

The report, The Mortgage Crisis: Economic and Fiscal Implications for Metro Areas, was prepared by Global Insight and released in conjunction with this week’s meeting of mayors, mortgage industry representatives and community advocacy groups in Detroit.

But as home appreciation abated, home sales plummeted and a wave of adjustable-rate resets hit, delinquencies and foreclosures began to rise.

Led by the Midwestern states of Indiana, Michigan and Ohio, foreclosures began to skyrocket in 2006. Soon after, markets in California and Florida — which experienced some of the highest growth during good times, saw rising delinquencies and foreclosures.

“The final straw occurred in the summer of 2007, as institutional holders of mortgage-backed securities realized the risk in their portfolios,” Global Insight wrote. “Credit dried up — for refinancing, for subprime buyers, and also for jumbo mortgages which lacked the guarantees provided by Freddie Mac and Fannie Mae.”

Next year, foreclosures are projected to increase by at least 1.4 million. Home prices are expected to drop an average of 7 percent during the period, while housing starts will fall 20 percent from their current level to 1 million and existing home sales will drop 10 percent.

“The wave of foreclosures that has rippled across the U.S. has already battered some of our largest financial institutions, created ghost towns of once vibrant neighborhoods — and it’s not over yet,” the study stated.

In just Arizona, another high-growth state during the boom, foreclosures are forecast to rise by over 60,000 in 2008 and home values are expected to fall $30 billion.

“It was the sharp increase in this lending in 2004 and 2005, with rate resets in 2006 and 2007, which has led to the mortgage mess in 2007,” the report said. “Suddenly, buyers who would not have qualified for mortgages at the reset rates have found themselves with a home they are unable to pay for or to sell.”

U.S. homeowners are expected to lose $1.2 trillion in property value next year as a result of the crisis, the report said.

The study estimated that nationally, 524,000 fewer jobs will be created next year as a result of the crisis. Lost tax revenues in just 10 states could potentially reach $6.6 billion.

The economic impact to states will be worst in California, which is projected to lose nearly $3 billion in property tax revenues and nearly $1 billion in sales tax revenues.

Economic output losses for 361 metropolitan areas will reach $166 billion next year. Just looking at the top 10 areas, the economic impact is estimated at $45 billion. Myrtle Beach, S.C., will lose the most — with growth estimated at 1.7 percent less than if no mortgage crisis had occurred. The New York City area is expected to lose more than $10 billion, while the impact to Los Angeles is projected at $8.3 billion.

“The foreclosure crisis has the potential to break the back of our economy,” Trenton, N.J., Mayor Douglas Palmer said in an announcement. Palmer is the president of the U.S. Conference of Mayors.

But, the authors added, “the mortgage crisis is not going to bring the economy grinding to a halt.”

The Mortgage Bankers Association has partnered with the conference to create a national online database to help cities identify the owners of foreclosed properties, the announcement said.

Plans to fend off foreclosures includes a boost the number of counselors and the organization of an advertising campaign about counseling services.

The report recommends that servicers and bond investors agree to modify loans.