Recently I talked with a prominent Billings Realtor. He stated that prices could not fall significantly in Billings, because our level of foreclosures is not that high. I countered that other markets around the country had seen falling prices even with low foreclosure numbers. In fact, prices fell first and then foreclosures started spiking.

Across the country, we've seen the same thing happen in hundreds of markets this decade. Prices increased at very high rates, construction boomed, then sales dropped as housing became unaffordable, prices fell, and defaults went up.

The surprising thing is that this largely happened even in the face of a seemingly good economy. Outside the Rust Belt, most places still had lots of jobs. But the key was that the jobs did not pay nearly well enough to justify the high prices of housing. Thus, housing did not collapse because of outside economic factors. Housing instead imploded on itself, taking the economy down with it.

Montana is behind the curve, but we could very well see the same thing happen here.

It has been over 20 years since the last downturn in the Billings market. In the 80's oil bust, Billings was affected in a big way. Businesses closed down and thousands of people left town. House prices plunged 30-40%.

While there are many things to learn from studying the 80's market, it's also helpful to remember that every downturn is different. Housing is in danger of a steep drop again, but not for the same reasons it was 20 years ago. Although our latest boom has been modest by comparison to the rest of the country, we've still seen house prices rise to levels that are largely unaffordable by Billings workers. This could lead to housing collapsing even without other major economic trouble.

Once you enter this type of declining market, defaults and foreclosures increase. Here are some reasons why:

• Speculators get burned
• Refinancing becomes difficult, which is disastrous if you have a resetting ARM or teaser rate
• People who could not really afford their homes, but were hoping for high appreciation rates, instead find themselves underwater
• Builders are unable to sell spec homes thanks to plunging sales
  

All right, enough talk. Let's look at some actual data on Billings foreclosures.

The most readily available foreclosure-related data in Yellowstone County comes from "Notices of Trustee's Sales," or NOTS. A NOTS being posted for a property means that the owner is at least 3-4 months late on payments. If payments are not caught up, the property will be sold at auction (or returned to the bank) within 6 months. Typically, about 1 in 3 properties given a Notice of Trustee's Sale is eventually foreclosed on.

Here is a graph of monthly Trustee's Sale notices in Yellowstone County since 1998. There is no major trend yet, although we have seen some significant spikes in the last few months.



I wanted to dig deeper into the data, so I took a look at the actual principal amount owed on loans that are in default. This graph is based on sampled data from each year.



Loan balances are increasing, which is not too surprising given that house prices are up too. However, the amount of increase in 10 years-- 3 times-- is pretty dramatic. High-priced homes and some very large loans have been going into default this year.

Next, I took a look at the age of the loan being foreclosed on each year. In a normal and healthy market, higher loan ages are expected. When sensible loans are being made, foreclosures should only happen in drastic circumstances such as job losses or disastrous medical bills. Since these can happen equally with a 10-month-old loan or 10-year-old loan, the median loan age tends to be pretty high.

In contrast, in an overheated market marked by lax lending standards and overextended borrowers, you will see much more recent loans going into foreclosure. Now, on to the graph:



Median loan age has in fact been going down considerably in the last 10 years. Combine this information with the graph above, and you get a very interesting picture of the state of housing default in Yellowstone County. Dozens of very recent loans-- some less than a year old-- are going into default for some very high dollar amounts. This to me paints a picture of a market that may soon be in serious trouble.

Remember, next time you hear media reports of "low foreclosures in Montana", that foreclosures are a trailing indicator this time. Foreclosures are not too high yet, but they will be if prices keep coming down.