Is distressed house inventory actually twice as large as commonly reported?
One of the contentious issues between housing bulls and bears is the existence of shadow inventory. Many bulls deny this inventory exists, and those that acknowledge it deny its impact. Many bears claim this inventory is much larger than reported, and some claim it will be unleashed on an unsuspecting public leading to catastrophic price declines.
One of the main problems with shadow inventory is defining exactly what it is. There is no commonly accepted definition. Corelogic has the most widely accepted definition which includes the number of distressed properties not currently listed on the MLS that are seriously delinquent, in foreclosure, and REO. Shadow inventory has been declining largely due to the can-kicking loan modifications with their 40% failure rate temporarily lowering the delinquency counts.
My definition of shadow inventory is outlined in the graphic below. After a borrower becomes delinquent, there is customarily a small window between their first reported delinquency and when the lender files the first notice of default. Prior to the collapse of the housing bubble, this first NOD went out 90 days after the borrower quit making payments. Once lenders became overwhelmed by the volume of delinquent borrowers, these timelines got extended, often for many years.
The borrowers who are not paying their mortgage, yet haven’t received a Notice of Default are what I consider the true shadow inventory. We know these people exist for several reasons. First, the number of loans more than 90 days delinquent is much larger than the total number of homes in the foreclosure pipeline. Estimates vary widely, but the obvious discrepancy between the two figures proves this inventory exists. And of course, the anecdotal evidence is seen every day on this blog where borrowers have been allowed to squat for years before the banks got serious and booted them out. I only do one post per day, so we only see the tip of a much larger iceberg.
07/18/2013 By: Esther Cho
YouWalkAWay.com, a national foreclosure agency, recently released a June 2013 survey of its customers and found 54 percent are in pre-foreclosure, meaning they have defaulted on their mortgage but have not received an official foreclosure notice.
Percentage of YouWalkAway clients in pre-foreclosure and average number of months past due. Source: YouWalkAway.com
Be certain you understand the ramifications of this. In California only 59% of their clients have received a notice of default. That means 41% have not. For every six borrowers that show up foreclosure filings, four delinquent borrowers are missed.
The share is down from 2012, when 85 percent of YouWalkAWay clients reported they were in pre-foreclosure.
The can-kicking and endless loan modifications are having impact. This is the group lenders have been reaching out to and begging to make some kind of payment. Lenders know they have no leverage because their threats to foreclose are empty, so they keep improving the deal hoping a few more delinquent mortgage squatters will bite. Rising prices and improved loan modification terms are motivating some to start paying again.
On average, clients who were in pre-foreclosure were 20 months behind on their mortgage payments.
According to the agency, pre-foreclosures are typically unaccounted for since reliable data is hard to find. However, YouWalkAway was able to compile pre-foreclosure data based on its client base to gain a better understanding of how prevalent this type of “shadow inventory” might be.
Data from the agency revealed Georgia has the highest share of YouWalkAway clinets in pre-foreclosure, at 82 percent. On average, clients in the state were behind by 18 months, but still haven’t been served with an official foreclosure notice.
In Minnesota and Arizona, 79 and 74 percent of clients, respectively, were in pre-foreclosure status. Customers in those states were behind by over 20 months.
The state that saw the biggest year-over-year decrease in clients in pre-foreclosure inventory was Florida, where 23 percent of clients were in pre-foreclosure, down from 45 percent in 2012. The average number of months past due though increased from 17 months in 2012 to 23 months in 2013.
Whatever the shadow inventory numbers really are is not the big issue, it’s what the lenders are going to do about it that’s important.
What will happen to shadow inventory?
As I stated at the start of this post, “Many bulls deny this inventory exists, and those that acknowledge it deny its impact. Many bears claim this inventory is much larger than reported, and some claim it will be unleashed on an unsuspecting public leading to catastrophic price declines.” Let’s take these contentions one at a time and make an educated guess as to what will happen.
First, “Many bulls deny this inventory exists.” Anyone who makes this statement is either an NAr shill, dangerously misinformed, or completely clueless. It’s not possible to argue with a person who states this because there is no agreement on facts. They are simply wrong.
Second, “Many bears claim this inventory is much larger than reported.” Keith Jurow makes a strong case that shadow inventory is widely underreported. The banks don’t have any incentive to provide accurate data to CoreLogic, particularly if that information is scary to the general public. However, nobody can definitively say how many borrowers are delinquent, and we are forced to accept the word of those who compile what data we have.
Third, “some (bears) claim (shadow inventory) will be unleashed on an unsuspecting public leading to catastrophic price declines.” I used to believe this. The change in accounting rules in 2009 which allowed shadow inventory to exist at all made this outcome less likely. However, for another three years, lenders still processed far more foreclosures than the market could absorb, and market prices kept dropping. When put together with an industry-wide effort to can-kick with endless loan modifications, lenders finally dried up the MLS inventory and changed the nature of shadow inventory completely.
Fourth, “(Many bulls) that acknowledge (shadow inventory) deny its impact.” I used to believe shadow inventory was going to be a real problem, but I have since changed my mind. Back in March, I wrote the groundbreaking post, Must-sell shadow inventory has morphed into can’t-sell cloud inventory. I believe the banks have found a way to successfully liquidate without causing a price crash — they simply withhold all houses from the market until market pricing brings them back above water. Of course, this allows for an enormous amount of delinquent mortgage squatting, but the banks reason that is superior to them taking a loss, so they allow it.
So what would make prices go down?
We know house prices drop when must-sell inventory comes to market, but the policies of lenders have removed most of the must-sell inventory from the market. Even if interest rates go up and peak prices become unfinanceable, so what? Lenders will just wait until wages catch up. They have no reason or incentive to process foreclosures. Even if the sales volume plummets and nothing sells because nobody can afford what the bank wants to get, so what? The banks don’t care. Just like the Irvine Company didn’t care if they sold anything from 2007 to 2009, the banks won’t care if even one house sells if it prevents them from taking a loss. Unless the realtor lobby somehow applies pressure on the banks to release some inventory, the market may seize up, but the banks can largely stop prices from going down by maintaining their stranglehold on the MLS.
Can withholding inventory solve all the bank’s problems?
Banks withhold inventory from the MLS in three ways. First, they give loan modifications to any underwater borrower that asks to keep them making a payment while prices rise back to peak levels. Second, they deny short sales to underwater borrowers with the assets to repay the loan balance (those they still have leverage over). And third, the allow delinquent mortgage holders who refuse to agree to loan modifications to squat until the property values rise to the outstanding balance of the loan. This policy is very effective and drying up the MLS inventory (see: Low housing inventory is an indicator of residual mortgage distress, and Las Vegas: a case study in successful housing market manipulation)
So can this policy take them all the way back to peak pricing and complete liquidation of all distressed loans? That’s where we have to get in order for the banks not to be burdened by $1 trillion in unsecured mortgage debt. So let’s run these policies forward and speculate on what will happen.
“First, they give loan modifications to any underwater borrower that asks to keep them making a payment while prices rise back to peak levels.” In my opinion, banks can repeat this endlessly. We know they’ve already given some borrowers multiple loan modifications, and the borrowers keep re-defaulting. I see no reason they can’t modify these loans over and over again as they have already been doing, so it looks like that one can go on forever if necessary.
“Second, they deny short sales to underwater borrowers with the assets to repay the loan balance.” This is what lenders should have been doing in the first place. This is what they would do under normal circumstances, so I see no reason they wouldn’t continue this policy in the future. They can effectively keep inventory off the market indefinitely. At some point, loanowners might strategically default to move for a job or a variety of other reasons, but that won’t stop the bank from going after them in debt collection for their assets.
“And third, the allow delinquent mortgage holders who refuse to agree to loan modifications to squat until the property values rise to the outstanding balance of the loan.” This is where it gets dicey. Lenders have been doing this for six or seven years now. The vast majority of those more than 90-days delinquent were loans originated from 2004-2007, and many of these have been delinquent from 2007 to 2009 until now.
Lenders have been able to sustain delinquency rates north of 10% because they have almost no carrying costs. They borrow money for nothing from the federal reserve, and they pay depositors next to nothing. As long as interest rates remain low, there is no reason to think they can’t keep squatters in their houses.
Long-term delinquency tends to promote strategic default. As the word gets out that borrowers can obtain free housing by simply stopping payment, many borrowers chose to do so. It’s one of the reasons places like Las Vegas have such atrocious delinquency rates. Word spread, and so did the delinquencies. However, with rising house prices, strategic default slows down. Loanowners start to see a light at the end of the tunnel, and many who were contemplating strategic default instead chose to keep paying with the hope of future equity.
Where this policy runs into problems is what happens when interest rates go up, or house prices stop going up. What happens if these borrowers never get back above water? Will the banks eventually foreclose and absorb the losses? I think they will have to, but if they delay it long enough, the amount will be so small they can afford to take the hit. In the meantime, I may be covering stories of squatters who spent their entire adult working lives without a house payment courtesy of a bank trying not to take a loss.
- The former owners of today’s featured property paid $217,000 on 5/26/1994 using a $203,150 first mortgage and a $13,850 down payment.
- On 2/27/1998 they refinanced with a $200,000 first mortgage. So far, so good.
- On 7/6/1998, the took out a $35,000 stand-alone second. This was their first taste of Ponzi money, and it appears they liked it.
- On 7/8/1999 they refinanced with a $235,000 first mortgage, and took out a $97,458 stand-alone second mortgage.
- On 12/27/2001 they refinanced with a $348,000 first mortgage.
- On 8/28/2002 they refinanced with a $350,000 first mortgage.
- On 8/19/2003 they opened a $100,000 HELOC.
- On 5/15/2005 they refinanced with a $550,000 first mortgage.
- On 7/12/2005 they obtained a $175,000 HELOC.
- On 4/24/2007 they refinanced with a $660,000 first mortgage.
- On 6/11/2007 the opened a $123,750 HELOC. That’s when the housing ATM was shut off.
- Assuming they maxed out the final HELOC, total property debt was $783,750, and total mortgage equity withdrawal was $580,600.
Since these borrowers were obviously Ponzis who came to rely on the free money provided by a bevy of stupid lenders, when the housing ATM was shut down, they struggled with the mortgage. The quit paying the mortgage sometime in 2009 and were finally served notice in early 2010. The bank let them squat for another year before finally foreclosing in February of 2011. Then the bank sat on the property for a year and half waiting for prices to rise.
These people only put $13,850 down, and they extracted $580,600, plus they got to squat for two years.
Bank robbery has become much more sophisticated in the 21st century.
[idx-listing mlsnumber=”OC13139253″ showpricehistory=”true”]
26611 MORENA Dr Mission Viejo, CA 92691
$572,250 …….. Asking Price
$217,000 ………. Purchase Price
5/26/1994 ………. Purchase Date
$355,250 ………. Gross Gain (Loss)
($45,780) ………… Commissions and Costs at 8%
$309,470 ………. Net Gain (Loss)
163.7% ………. Gross Percent Change
142.6% ………. Net Percent Change
5.0% ………… Annual Appreciation
Cost of Home Ownership
$572,250 …….. Asking Price
$114,450 ………… 20% Down Conventional
4.37% …………. Mortgage Interest Rate
30 ……………… Number of Years
$457,800 …….. Mortgage
$112,241 ………. Income Requirement
$2,284 ………… Monthly Mortgage Payment
$496 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$119 ………… Homeowners Insurance at 0.25%
$0 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,900 ………. Monthly Cash Outlays
($428) ………. Tax Savings
($617) ………. Principal Amortization
$182 ………….. Opportunity Cost of Down Payment
$163 ………….. Maintenance and Replacement Reserves
$2,200 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$7,223 ………… Furnishing and Move-In Costs at 1% + $1,500
$7,223 ………… Closing Costs at 1% + $1,500
$4,578 ………… Interest Points at 1%
$114,450 ………… Down Payment
$133,473 ………. Total Cash Costs
$33,700 ………. Emergency Cash Reserves
$167,173 ………. Total Savings Needed