What will the banks do?

The weak housing market has long been a drag on state and national economic growth but, up until recently it appeared that prices had hit bottom and a slow but steady recovery was underway. Since the expiration of the federal housing tax credit, however, the recovery in the housing market appears to have stalled. 

According to First American Core Logic, in the second quarter 15% of Massachusetts homeowners with mortgages were in a negative equity or "underwater position" (versus 23% nationwide). And according to the Warren Group, foreclosures are way up and sales are down in Massachusetts of late.

A major wild card in all of this is well described in a recent Wall Street Journal article.  The article highlights how important the decisions banks make in how they dispose of their REO portfolio (the foreclosed properties they own) will be to the future trajectory of the housing market.

With demand for housing continuing to wane, a potential flood of bank owned properties into the market could force housing prices down further, pushing more homeowners "underwater" and fueling a vicious and self reinforcing circle that is now in its fifth year. 

The job market is another wild card here.  Here in Massachusetts, if we can continue to add jobs at current pace, I think that household finances should be stable enough to allow more families to keep current with their mortgages and slow the pace of foreclosure activities.  If not, more foreclosures seem inevitable.

You would think that any self respecting bank would consider holding onto properties so that they don't end up racing each other to the bottom.  But most banks hate being landlords and so, if history is any guide here, it seems likely that the supply of these homes on the market will increase. 

Considering that housing supply already appears to be rising, it is beginning to look like we are in for another round of housing price declines.