In pockets of foreclosure, housing woes spread block by block

In Modesto, Calif., home prices could fall as much as 25 percent.

Pushing up against almond groves and dirt-bike trails, the row of homes on St. Salazar Circle marks the furthest advance of Modesto's housing boom – and the start of its scorched-earth retreat.

Brown, unwatered lawns of foreclosed homes compete with the green grass of neighbors still hanging on. Some of the structures, although new, are missing outdoor equipment like air conditioners, taken by metal thieves. One in 4 houses of the neighborhood stands empty, and mortgage defaults are certain to push even more residents, mostly Hispanic immigrants, out of their homes.

It's a sign of the home-loan crisis' uneven impact: light in some areas, heavy in others – often those populated by minorities or the lower-middle class. The concern now is that the woes concentrated in these pockets of foreclosure will spread outward, causing home prices to spiral down rapidly and broadly.

How far could it spread? Much depends on how the overall economy performs. Things like gas prices, job creation, and pay hikes will affect how many homeowners are driven into foreclosure. The biggest danger may be the sinking housing market, with negative forces feeding off each other: Falling home prices, reluctant buyers, distressed sellers, and tighter lending standards by banks.

In a worst case, economists say that a deep national recession is possible. Home prices could fall as much as 25 percent – more in places like Modesto and less in many towns that saw less of a boom. Bank woes could make credit dry up, while the declines in construction and housing wealth could hurt jobs and retail sales.

"Those risks are very large," says housing analyst Celia Chen at Moody's "It's very easy to paint a picture in which even corporations start to cave," in terms of their willingness to invest and hire.

But most forecasters don't see that happening.

Instead, many economists expect several quarters of barely perceptible growth – but no recession – followed by a gradual pickup beginning in the second half of next year. Their reasoning: Jobs and incomes will generally keep growing, thanks in part to growing exports in a healthy global economy. Policy efforts in Washington could also help to stem the pace of foreclosures.

Even without a recession, the baseline forecast of Ms. Chen and colleague Mark Zandi suggests that US home prices will eventually fall 15 percent from their peak. And they predict that 2 million home loans – about one in every 25 in America – are slated to enter foreclosure by 2009.

A crisis from the outskirts in

In the city made famous by the movie American Graffiti, the crisis is unfolding geographically. On its fringes, new neighborhoods, like the one surrounding St. Salazar Circle, the home-loan crisis has hit the hardest. Built during the height of the housing boom, they have the newest residents who paid the highest prices with the most exotic mortgages. After seeing prices rise 10 to 20 percent each year, they're now seeing prices slide downward.

"Right now, our dreams are being crushed," says Marisol Ramirez, a wife and mother of three who bought a home on St. Salazar last year for $370,000. Now, it's priced at $300,000 and the Ramirezes are likely to lose it.

Their troubles began when their home was robbed, something that grew common in the neighborhood with the lack of work and the empty homes. That sent their insurance rates higher. Then her husband lost his job in home construction: No one is building these days. They haven't made a mortgage payment in three months on their 40-year, no-money-down loan.

Now they are weighing whether to rent around Modesto or just return to Mexico. "I stay up at night with the fear that they'll come and take me out of the house with my children," Ms. Ramirez says.

Vacant homes surround her: the next-door neighbor, the house at the end of the block, three in a row behind her on St. Charlotte Ave.

Residents around St. Salazar worry about the effects of foreclosures on the area. On San Ramos Ave., thieves hauled off a heavy air conditioning system – a prelude to wholesale stripping, seen elsewhere in Modesto, of everything down to the copper wire yanked from the drywall.

That's the problem with foreclosures concentrated in a neighborhood.

"Default begins to feed on itself," says Stuart Gabriel, chairman of the real estate school at the University of California at Los Angeles. The banks holding foreclosed properties try to unload them, sometimes at fire-sale prices, depressing the home values of neighbors. If those neighbors' finances are shaky and they hold an exotic loan, the loss of value could trigger another foreclosure, starting the cycle all over again.

In La Loma, neighbors do lawn care

Such problems, in full swing around St. Salazar, are popping up closer to Modesto's center.

In the leafy La Loma area near downtown, Bill Graham is one of several residents looking after vacant properties.

"I come over here and mow this lawn – for the neighborhood," he says. "I hate to see people lose their homes to foreclosures, and I don't want to see it happen to myself either."

He's in danger of losing his main residence and another house in town once the adjustable rates go up again. He had planned to refinance to consolidate his investments, but that's looking unlikely.

More than 5,700 homes in Modesto's Stanislaus County are actively under foreclosure or have already been turned back to the bank, according to RealtyTrac, based in Irvine, Calif. – with a fresh wave expected after February's reset on adjustable-rate mortgages. Modesto has been trading honors with nearby Stockton and Merced for the dubious distinction of being the country's foreclosure capital.

A third of buyers had been investors

In Modesto, investors made up roughly a third of buyers in recent years, says John Hillas, a local appraiser. That's bad news for the city, since investors are more likely to default than live-in owners, according to Mr. Gabriel.

The good news is that more established neighborhoods typically have a larger share of owners who have built up equity and didn't use exotic loans to finance their homes. Risky interest-only and more unusual adjustable-rate mortgages are only a recent phenomenon – ballooning from 1 to 2 percent of loans in 2001 to more than 30 percent by 2006 nationally. So even in newer Modesto neighborhoods built around 2003, foreclosures haven't triggered the kind of unease evident in Ramirez's neighborhood. Many residents say they are not worried about losing their home because they have fixed-rate mortgages and can wait out the downturn.

"What we're seeing in the data is that the earlier vintages – those loans originated in earlier quarters and years – are performing better than the more recent vintages," says Gabriel.

Retail businesses related to housing – everything from appliances to carpet and furniture sales – have seen a downturn. But local charities and churches see little spike in demand for services, and the city center shows few outward signs of trouble except at the courthouse.

There, underneath one of the staircase entrances, hundreds of pages are tacked up, each sheet noting a foreclosed home to be auctioned that month. Hispanic names dominate. Each day at the stroke of noon, Dean Roots arrives at the courthouse steps to read the 40 or so new homes put on the block. Barely audible above the din of passing traffic and the blowing breeze, she reads the list of properties on offer like a long-memorized liturgy.

For months now, no more than a half-dozen onlookers have turned out for the ritual. On most days, no one even bids.

"I try not to think about it because a lot of these people have brought it on themselves," Ms. Roots says. "You don't know which ones are hardship cases."

Back on St. Salazar, Samuel Mendoza checks out a vacant home for sale. His older brother, Daniel, tags along with his own young child. Daniel's home is currently under foreclosure, so his family will be moving in with Samuel when he buys.

Samuel has many suddenly affordable options – an often unsung high note in the housing crisis. Several homes have already been purchased on nearby San Ramos, a sign that the neighborhood may be starting to stabilize. As Gabriel puts it, sometimes a "neighborhood has to convulse, it has to turn over."

Samuel likes the home on St. Salazar, but he's not about to make a rushed, ill-informed decision.

"We're going to learn from my mistakes so he doesn't go through the same thing," says Daniel.

Mark Trumbull in Boston and Nicole Hill in Modesto contributed to this report.

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Who's most at risk?

To some extent, every homeowner is hurt financially when home prices fall. Their net worth goes down, and that can affect spending and their ability to tap home-equity lines of credit. But some will bear a heavier burden than others.

Of America's 109 million households, nearly one-third are renters, largely unaffected by the rise and fall of home values. Another one-fifth own their homes outright: no mortgage, no credit risk. That leaves about 52 million mortgage-holders, according to numbers crunched by economist Gary Shilling in Springfield, N.J..

For them, the danger of foreclosure or bankruptcy depends largely on their financial situation and timing. Most who bought before the boom have either paid down a chunk of their mortgage or have seen a price run-up – cushioning them today. In contrast, those who bought near the peak – in 2003 or later – are more at risk.

If they took out an adjustable-rate mortgage, particularly a higher-interest subprime mortgage, they're the most at risk. Of those 52 million US mortgage-holders, 2 million may go into default – and ultimately foreclosure – between this year and 2009, according to Moody's

The severity depends a lot on geography. The forecast ranks only 80 of 381 metro areas as likely to see home prices fall by 10 percent or more. Still, those include some of the biggest cities on both coasts, plus Detroit and some desert and Rocky Mountain cities.

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