Drop in Foreclosures Isn't Bright Spot It Seems

The latest foreclosure numbers are in and, at first glance, they look promising.

Foreclosure filings declined an average 10% across the country in January, compared with December, according to RealtyTrac. Two of the nation’s most badly foreclosure-battered states, Florida and California, registered higher-than-average drops, of 20% and 14%, respectively. Nevada, which has the highest foreclosure rate in the country, saw a decrease of 4%.

So, is this the beginning of the end of the housing crisis?

Don't get too excited. “There’s a real danger right now in misreading what looks like a drop-off in [foreclosure] activity as being a cure,” says Rick Sharga, senior vice president at RealtyTrac.

Several factors played into last month's decline, including an unusually large number of foreclosures in December, as well as state and government actions that put a temporary hold on foreclosures.

Here's how to decipher the latest data and what to expect in the months ahead. (Brace yourself, it's not pretty.)

With over 303,000 households in foreclosure, December came close to setting a record, according to Sharga. “Any time you have a spike that high, the following month is likely to be a drop-off,” he says. Despite the 10% decline reported for January, the number of foreclosures during the month was the fourth largest since 2005, when RealtyTrac started tracking foreclosures.

Month-to-month comparisons can also be misleading, says Andres Carbacho-Burgos, an economist at Moody’s Economy.com. Short-term fluctuations can be too volatile for long-term conclusions to be drawn. “A three-month moving average might tell you a bit more about the underlying trends in foreclosures,” Carbacho-Burgos explains. (Moody’s Economy.com uses quarterly statistics from the Mortgage Bankers Association in its housing reports.)

In fact, compared with January 2008, foreclosure activity in January was up 18%, making it the 37th consecutive month with year-over-year increases, according to RealtyTrac.

Actions by Fannie Mae (FNM), Freddie Mac (FRE) and some individual states may have skewed the numbers as well.

First, a moratorium placing a hold on foreclosure actions against troubled home loans underwritten by Fannie and Freddie -- they control the majority of the mortgage market, now underwriting about 60% of all new loan originations -- was extended through the month of January, says Sharga. Separately, in December, Florida put a 45-day freeze on new foreclosure actions and the scheduling of foreclosure sales, resulting in a 20% drop in activity.

However, now that these temporary measures have expired, expect the foreclosure numbers to spike back up. “The problem with moratoria is unless there’s another program that goes out and restructures these loans, all we’re doing is delaying the inevitable,” says Sharga.

With the government in high gear working on its economic stimulus package, it’s likely that lenders are putting foreclosures on hold and waiting to see what gets passed, says Carbacho-Burgos. “Banks may decide to not foreclose on bad mortgage loans if they believe that they can get some benefit on these loans once Congressional legislation passes,” he says. Whether those benefits will materialize, however, remains to be seen.

Ultimately, the fate of the housing market — and the number of foreclosures — is closely tied to the labor market. “We won’t see the light at the end of the tunnel until the economy stops losing jobs,” says Diane Swonk, chief economist with financial-services firm Mesirow Financial.

Home prices also need to recover. Moody’s Economy.com doesn’t expect a housing recovery until 2010. “As prices continue falling through 2009, there will be more and more homes with negative equity and that’ll be a substantial incentive to default on mortgage loans,” Carbacho-Burgos notes. “That’s why we’re not seeing a sudden improvement in foreclosure rates.”