11.8% of all loans at least 30 days past due or in foreclosure in 2012

Lenders hope they can solve all their problems by making the housing market hit bottom. If prices bottom, people who bought at the bottom gain equity with rising prices, and they in turn reignite the move-up market which will allow the banks to sell their high-end shadow inventory. Further, rising prices makes for fewer short sales and fewer foreclosures and distressed sellers become equity sales. Rising prices would be a panacea for lenders, which is why the full weight of our government and the federal reserve is working to make house prices go back up. They tried and failed to create a bottom in 2009. They hoped they had created momentum with tax credits in 2010. They failed.

Lenders and the federal reserve are at it again. Mortgage interest rates are now down to 3.75%, and lenders are withholding inventory from the MLS to prevent further price declines. Again they hope they can create an artificial bottom and momentum to carry them through the liquidation of their distressed inventory. This time around, interest rates are lower, and the economy is better; however, they are still faced with a huge overhead supply that will take years to sell off.

If lenders are successful in engineering a bottom and creating momentum, they will all celebrate their success, but then they will return to the dirty business of selling distressed inventory and recycling the millions of bubble-era loans. Loan modification programs are a proven failure with redefault rates at 50% within a year of initiation, so these houses will eventually have to be sold to new borrowers with income capable of sustaining ownership. Even if prices begin to rebound, many sellers will sell when they get back to breakeven because they can’t afford their payments over the long term without HELOC supplementation. There is no way to avoid millions of distressed sales.

Foreclosures Show No Sign of Decline

By NICK TIMIRAOS — Updated May 16, 2012, 7:57 p.m. ET

At the end of March, 11.8% of all loans were at least 30 days past due or in foreclosure, the report from the Mortgage Bankers Association said. While that is still high by historical standards, it has improved steadily over the past two years, falling from 12.8% a year ago and 14.7% two years ago.

The decline in the share of homeowners late on payments was due almost entirely to fewer new cases of delinquency, a sign that households’ finances are improving. The percentage of borrowers behind on their mortgage but not in foreclosure fell to 7.4% at the end of March from 8.3% a year earlier.

“The drops we continue to see there are the best news out of this. It indicates the speed with which we’re working through the backlog” of bad loans, said Jay Brinkmann, chief economist of the Mortgage Bankers Association. The survey covers about 88% of all U.S. mortgages, or about 43 million loans.

The drop in the delinquency rate does not reflect the speed at which lenders are processing the backlog. Many of these loans were modified which means they will redefault again later. Even at their 0.9% annual rate of decline in delinquency, it will take another three or four years to get back to historic norms. It will take longer than that to process the resulting foreclosures and eliminate the inventory.

Several nonjudicial states that had severe housing problems, such as California and Arizona, have seen foreclosure rates drop below the national average. While there are signs that home prices are beginning to rise in more markets, including hard-hit Phoenix and Miami, those communities with a large “shadow” inventory of potential foreclosures could face renewed price pressure once banks take back and list for sale more of those properties.

In those states, investors have grown more confident that more foreclosures won’t be dumped on the market, said Mr. Brinkmann. There, “the market is stabilizing and people are coming back. …”

Withholding inventory doesn’t make it go away. 8.7 years from now when delinquency and foreclosure rates drop back to historic norms because we are finished processing all the distressed inventory, then I won’t worry about the impact of shadow inventory. Until then, caution is warranted.