Foreclosures chill once-hot Southeast housing market

EconSouth, Fall, 2008 by William Smith

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Housing markets in the Southeast once sizzled like an August afternoon, helping to heat up the region's economy. But a cold wave of foreclosures has crashed through many of the region's housing markets, and its ripples have spread through most corners of the region. The eventual toll this foreclosure wave will take on the region's economy remains to be seen.

During the housing boom of 2004-06, Atlanta's Pittsburgh I neighborhood briefly emerged as a magnet for new home construction. Builders saw opportunity in a previously neglected area across Interstate 75-85 from Turner Field (the Atlanta Braves stadium), an area that provides easy access to Atlanta-area jobs.

For a while, prices of newer homes with top amenities in the gentrifying Pittsburgh neighborhood approached $400,000. But in 2007 these prices began tumbling, and within months foreclosures began to spread quickly from house to house.

Today, boarded-up windows and overgrown landscaping characterize this once up-and-coming community. For sale, for lease, and foreclosure signs proliferate like the dandelions in the lawns. LaShawn Hoffman, chief executive officer of the Pittsburgh Community Improvement Association Inc., which promotes economic and community development in the Atlanta neighborhood, said new working families began moving into the area a few years ago. Many of them were renters who have now been forced out as banks repossess properties from absentee speculators who failed to pay their risky mortgages. The dwindling number of remaining residents find themselves constantly on guard against squatters trying to move into abandoned properties.

Foreclosure spreads its tentacles

While the Pittsburgh neighborhood of Atlanta--also known as Adams Park--offers an unusually concentrated microcosm of foreclosure issues, it is by no means an isolated case. A sudden and widespread increase in bank-owned real estate has broad economic and social consequences. While many areas in the Southeast have not been directly touched by foreclosures, the problem has exacerbated an overall decline in house prices and economic weakness throughout much of the region.

Since 2005, foreclosure rates in Southeastern states have risen. The hardest-hit state is Florida, followed by Georgia, where the chief problems are in parts of the Atlanta metropolitan area.

Foreclosures have swept through communities with surprising speed. Just three years ago, Florida was below the national average in foreclosures. But the state now has the highest foreclosure rate in the Southeast, with almost 4 percent of mortgages in foreclosure in 2007, according to the Mortgage Bankers Association (MBA). Florida's foreclosure rate in 2008 has continued to climb.

In Georgia, 3.23 percent of all mortgages were in foreclosure in 2007--up from 2.56 percent in 2006. As in Florida, Georgia's foreclosure rate surged in the first half of 2008 (see the maps on page 6).

But the rate is not as high throughout the region. For example, according to data from the MBA, the foreclosure rate for Alabama at the end of 2007 was 2.37 percent--the lowest rate in the Southeast and below the national average of 2.84 percent. Foreclosures in Tennessee and Louisiana are also below the national average but are up from a few years ago. Mississippi's foreclosure rate has increased sharply, to about 3.5 percent at the end of 2007.

Housing price depreciation is a key culprit

The increase in foreclosures can be attributed to many factors, such as mortgage fraud and predatory lending. While acknowledging these issues, Atlanta Fed financial economist and policy adviser Scott Frame said one economic dynamic underlies almost all foreclosures: the decline in house prices.

Frame traces today's foreclosure problems to the rapid increase in house prices that took place a few years ago. U.S. house prices appreciated more than 55 percent between 2001 and 2006, driven primarily by income growth, low interest rates, and, in certain markets, supply constraints.

As housing affordability declined, subprime lending increased significantly with the availability of new and untested mortgage products. By 2006, about 20 percent of new residential mortgages were subprime; in other words, one in five mortgage borrowers had either low credit scores, high levels of debt compared with income, high mortgages compared with their homes' value, or unverified income. Many of these high-risk borrowers were buying houses with minimal or no down payments just as prices were peaking.

"The path of house prices appears to be very important--in both theory and in practice," Frame said. "Negative equity [owing more than the house is worth] is a necessary, but not sufficient, condition for foreclosure."

In principle, if they have positive equity, homeowners can either borrow to cover temporary shortfalls or sell the house. But owner-occupiers do not default simply because they have negative equity. Typically foreclosure involves a significant trigger event related to household budgets such as job loss, divorce, or large medical expenses.