Foreclosure Moratorium Will Only Make Bad Situation Worse

David Dayen of the FireDogLake blog reported on Thursday that “Harry Reid, the Senate Majority Leader, just sent a letter to the largest mortgage servicers in Nevada, asking them to suspend all foreclosure operations in the state.”

And in the age-old spirit of monkey-see-monkey-do, the RJ reported on Friday that Nevada AG Catherine Masto “sent letters to all residential mortgage lenders in Nevada, asking them to temporarily halt foreclosures, evictions and sales of foreclosed properties.”

Sounds good, right? Right. Then again, remember that the road to hell is paved with good intentions. Let me explain why a foreclosure moratorium will actually make the situation worse. Much worse.

Many homeowners trying to negotiate with their banks to keep their homes rather than lose them to foreclosure have had no success whatsoever. The most common complaint is that the banks have no interest in such mediations whatsoever. And why should they?

If they foreclose on a home, insurance and the government will make the bank whole….and they have the added benefit of then being able to sell the house to a new homeowner. The banks win when you lose. There’s simply no incentive for them to make a deal.

Of course, this has resulted in thousands of underwater homeowners who have simply stopped making their monthly mortgage payments and are instead putting that money in the bank each month for as long as they can until the bank takes their house. At that point they’ll then have a pretty sizeable nest egg saved up and will just sit out of the market for three or four years and then be eligible to buy again – likely for a MUCH LOWER price than the home they’re now losing.

So what does issuing a government-orchestrated moratorium on foreclosures mean?

It means a whole lot of people who have been grappling with the decision on whether or not to go down this route are suddenly going to realize that as long as the moratorium is in place, they’re not going to lose their houses….so why not stop making the payments? It’s that much more cash they’ll have in the bank by the time the banks start kicking people out again.

By halting foreclosures in this market, even if only temporarily, all it will do is encourage more folks to walk away. It will exasperate the existing crisis, not alleviate it, proving once again that the government is the problem, not the solution.