It’s now looking like over-correction in prices is a likely possibility in the Phoenix area residential real estate market.

Over-correction will cause unnecessary economic damage to home sellers and lenders. The lower home prices go, the more foreclosures there will be and the greater the losses to families and lenders.

Foreclosures Don’t Hurt Home Prices…

This may be trite but it’s true. Foreclosures, per se, are not driving down home prices. What drives down home prices is lenders reselling those foreclosed homes.

I don’t know of any law that says lenders have to resell foreclosed homes immediately. The banks, I assume, could instead lease out some of their foreclosed properties.

“Show Me the Money!”

Banks, of course, want cash to lend not real estate to hold. Perhaps the banks could use the homes as collateral to borrow money at extremely favorable rates from the Fed or Treasury. I’m not a banking guy but that would seem to be key.

The foreclosure problem is much too big, of course, to use this strategy across the board. It can, however, be used surgically.

“Scalpel”

Some zip codes in metro Phoenix in my opinion are clearly well valued or under valued. They tend to be those zip codes on the periphery of the metro area where prices first started to fall and where prices have fallen the most.

What if a group of large banks agreed to NOT resell their foreclosures in those zip codes where the median price per square foot was less than, say, the 2003 median price per square foot? That could very well lead to prices stabilizing more quickly and at higher levels in those zip codes.

And that would minimize the over-correction not only in those few zip codes but in the entire Phoenix real estate market!

That’s because encouraging prices to stabilize in the most over-corrected zip codes would stop those zip codes from continuously pulling down prices in neighboring zip codes. Price stability might ripple out from the stabilized zip codes.

Once home prices stabilize in a few zip codes, the entire market psychology will change dramatically. There are many potential buyers who would be happy to pay today’s prices but think, “Why buy now when prices are still falling.”

If, as well, punitive lending standards and PMI were relaxed in those stabilized zip codes, non-government mortgage money would flow in and the recovery would be well on it’s way.

Race to the Bottom

Lenders just need to change their paradigm about not being landlords or otherwise not holding assets in inventory.

Currently, lenders sell foreclosures as quickly as possible in a competitive race to the bottom with other foreclosure-selling lenders. Lenders, however, could conceivably support prices once they agree the bottom has been overshot in a zip code.

Irrational Pessimism

In those zip codes that have indeed over-corrected, the strategy could help minimize the ultimate amount of the over-correction which would benefit both homeowners and lenders.

Indeed, if the lenders end up keeping truly under-valued assets, the lenders could make a profit in a few years using the strategy.