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Foreclosure Backlog Grows

Stocks in this article: XLF XHB IYR IYF

NEW YORK ( TheStreet) -- The delay in clearing the backlog of problem loans in states with strict foreclosure laws is only increasing, casting a shadow on the housing recovery.

The long pipeline is not limited to states that follow a so-called "judicial foreclosure process." Other states, including Massachusetts, Nevada and California, have enacted "judicial-like" foreclosure laws that have dramatically slowed down the foreclosure process.

Working through the existing backlog of loans in default or in foreclosure will take 62 months in judicial states at today's rate of foreclosure sales, according to the January Mortgage Monitor Report from Lender Processing Services(LPS). That is nearly twice as high as the 32-month average in non-judicial states.

The foreclosure inventory rate -- the number of loans in default or foreclosure -- in judicial states is three times that of non-judicial states.

States that follow a judicial process require banks to seek court approval before pursuing foreclosure action. About 22 states use the judicial foreclosure process as their primary method, according to Mortgage Bankers Association.

"A few judicial states -- New York and New Jersey in particular -- have such extreme backlogs that their problem-loan pipelines would take decades to clear if nothing were to change," according to LPS Applied Analytics Senior Vice President Herb Blecher.

States that have recently enacted "judicial-like" foreclosure processes are seeing a growing backlog.

"Nevada's 'time to clear' has extended from 27 months in January 2012 to 57 months as of January 2013," Blecher said. "The change in Massachusetts has been even more pronounced. Since June of last year, its pipeline ratio has gone from 75 to 171 months. As California's recently enacted Homeowner's Bill of Rights is closely modeled on the Nevada legislation, we'll be watching that state closely over the coming months to gauge its impact, as well."

While the laws are designed to protect borrowers, recent housing data has shown that they have also limited price gains.

States such as Arizona have rapidly cleared their inventory and are now seeing strong gains from the bottom, but states such as New York and New Jersey have lagged.

The longer a home stays in foreclosure, the greater the chances of blight, resulting in a deterioration in value. Foreclosed homes also have the effect of depressing neighborhood prices, so you are hurt when you neighbor is in foreclosure.

In some cases, there is a moral hazard issue as well, as borrowers in default get to live rent-free in their homes while they wait for their case to go through the pipeline.

Still, the laws have prompted banks to pursue alternatives to foreclosure over the past year such as short sales and modifications.

Consumer advocates argue that the alternative resolutions are necessary, and that the difficulty in foreclosing on borrowers should ensure that banks are more responsible in their lending in the future.

-- Written by Shanthi Bharatwaj from New York

Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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