Standard & Poors today released "The Shadow Inventory Of Troubled Mortgages Could Undo U.S. Housing Price Gains".

Noting that the Case Shiller/S&P Home Price Index had risen 3 percent since hitting its low in May of last year, today's report speculated that the increase may have been the result of the temporary reduction in foreclosures. However, it says that many servicers have nearly run out of plausible candidates for loan modifications and will find that many loans cannot be salvaged.

What S&P calls a "shadow inventory" may take as much as 33 months to clear at the current sales rate.  This is a conservative estimate according to S&P as it includes only those loans that are currently delinquent and does not take into account current and performing loans that may get into trouble in the months ahead.  This increased inventory indicates that home prices may fall again.  An S&P spokesperson said that loan servicers are increasingly looking to short sales as a solution.

The Wall Street Journal reported today that current loan modification efforts may be more of a delaying action than a panacea for the epidemic of foreclosures that has swept the nation.

The Journal said that two studies, one conducted for John Burns Real Estate Consulting, Inc. and the second by Standard & Poors Financial Services, LLC, anticipate that a large percentage of currently delinquent mortgages will eventually be foreclosed, painting a picture of continued excess inventory and a renewed downward pressure on housing prices.

The Burns study estimates that, of the estimated 7.7 million home loans that are currently delinquent, about 5 million will eventually be foreclosed or otherwise forced onto the market over the next few years.  These homes would add to the already large inventory of homes listed for sale, especially in four states that have been especially foreclosure-plagued.  The report names five cities in the Nevada, Arizona, California, and Florida where, if Burns estimates are correct, there could be backlogs of homes that would take 15 to 27 months to absorb. The increased national inventory would require 10 months to sell.  At the end of December FHA put the current national inventory at an eight months supply and falling.  

At the end of December servicers participating in the Treasury Department's Making Home Ownership Affordable (HAMP) program reported that about 3.4 million residential loans in their portfolios were 60 days or more delinquent.  About 900,000 of those are enrolled in trial modification programs, but as we have reported a number of times, the few permanent modifications arising from these trials - about 66,000 by the end of December - are a cause of serious concern. 

Another FHA report issued in January showed that the rescission rate on Fannie Mae and Freddie Mac's loan modification efforts was around 60 percent.  While there had been some marginal improvements in the rate of re-defaults among more recent modifications, taken together the two reports give some credence to the two reports.   

MND's Adam Quinones comments...

If anyone is searching for a glimmer of hope that the Fed's MBS program is extended...the above issue is one of your best chances. Remember what the Fed keeps telling us

"The Committee will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets."

While we remain skeptical that "shadow inventory" will actually be dumped on the market all at once by banks, we must remain respectful of the effects that unsuccessful loan modifications could have on the housing market. A spike in housing supply, for any reason, would be damaging to the marginal stabilization and progress made in housing over the summer months of 2009. But again, we are still somewhat optimistic that a home supply "spike" will not occur as a result of increased foreclosure activity. READ MORE

If you happen to be one of those folks who believes the Fed's MBS Program should be extended...I ask you this question: Are you cutting off your nose just to spite your face?

If the Fed was forced to extend the MBS purchase program, wouldn't it imply some key element of the housing market equation was too weak to be removed from life support?

Unless you believe that mortgage rates are going to skyrocket after the Fed exits the TBA MBS market, it seems like we face bigger problems. I know low mortgage rates were the biggest reason for business in 2009, but that won't be the case in 2010. Those borrowers, the ones who qualify, already took advantage of low rates. Originators will need a new source of business in 2010. Purchases are the immediate loan type that comes to mind. (redundent at this point)

If the purchase market fails, it wont be the fault of high mortgage rates. It will be the result of a lack of credit worthy borrowers. 

Consumer demand side support will be crucial if housing is to extend any progress that has been made in the last 6 months and unfortunately, there are several factors moderating growth in consumer demand.

Damaged consumer credit profiles need time for repair. This means a stable job will be required to ensure consistent payments are made and credit is properly mended. After that, total debt service payment can't be over 45% of total income. Jobs needed.

The job issue hits home extra hard in housing. Not only do consumers need jobs to qualify for a new mortgage, they need jobs to stay up to date on current mortgage obligations. All appers to be dependent upon EMPLOYMENT! Shadow inventory, consumer demand, and home prices.

Instead of spending money on the extension of the Fed's MBS purchases (in an already SLOW market), maybe the housing industry should be hoping for structural stimulus at the heart of the problem: job creation and credit repair. Low rates only go so far, we need credit profile healthy consumers!


We get another read on delinquencies when the Treasury releases monthly HAMP foreclosure prevention data tomorrow. HERE are the most recent results.