The lending cartel believes they can hold back the REO flood

In what can best be termed as delusional optimism, the lending cartel is cautiously optimistic they can control the flow of properties as the liquidate their shadow inventory.

Based on what is happening today, lenders have reason to be optimistic. Collectively, they are withholding REO inventory and decreasing the supply of distressed inventory to force the market to bottom this spring. They don’t have much to lose. If they keep putting properties on the market, prices will certainly continue to fall. They hope that by removing the inventory, they can get the markets to bottom and with the constant barrage of bullshit from the NAr, they may be able to ingnite a rally as everyone tries to time the bottom of the market.

It’s easy for lenders to unite to withhold inventory to reverse the direction of prices. Cartels work when the members have an alignment of interests; however, once prices start going up, each member has incentive to cheat and release product into the rising tide to hasten their own liquidations. That’s when the strength of the cartel is tested.

We know BofA and other banks began increasing their foreclosure efforts last fall, many of those properties will go to auction over the next few months. What will these banks do with those properties? They hope they will have demand to sell into. Perhaps they will. Assuming they don’t release too much product and crush the rally they are engineering.

History is not on the side of the cartel. These arrangement are notably unstable. They have their moments, but over the long term, the interests of the participants fall out of alignment, and cheating among the members destroys the pricing power created by withheld inventory. What is the fate of the banking cartel?

Home Prices May Withstand Foreclosure Wave

By Teke Wiggin — Posted Mar 30th 2012 1:00PM

At best, an increase in foreclosures takes a double-edged sword to the housing market. On the one hand, it means we may be inching toward stabilization, as shadow inventory begins to move through the pipeline. On the other, it spells more stress for beleaguered homeowners and puts downward pressure on home prices.

This is the dilemma facing lenders over the next several years as they work through shadow inventory. Lenders don’t make money from delinquent loans (although their books may say they do). Non-performing loans must be cleaned up, the losses written off, and new loans which do perform must be put in place. Lenders are not going to give away several trillion dollars worth of homes. This isn’t optional.

As lenders process these non-performing loans, they must be careful not to process them too quickly and flood the MLS with too many properties because it will push prices lower and cause other borrowers to strategically default. If they process these loans too slowly, the risk going broke. Bank expenses don’t decline if borrowers quit paying. In fact, they go up substantially as lenders must spend money on collections. If non-performing loans fester on their balance sheets too long, even the too-big-to-fail lenders will become insolvent.

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Housing economists predict that the next wave of foreclosures is about to hit, following the recent settlement between government and lenders in the “robo-signing” scandal. No doubt it will still cause pain to hard-pressed borrowers. But in a break from the past, it may avoid depressing home prices. “There are countervailing strengths,” said Mark Fleming, chief economist at CoreLogic, an analytics firm. “We could very well see increasing prices in some markets this year, even though they have significant shadow inventories.” The “shadow inventory” is the overhang of homes expected to move through foreclosure that are not yet listed on the market.

Shadow inventory is not for-sale inventory, and if REO are kept in the shadows or sold in bulk to investors as rentals, lenders may succeed in keeping prices from going much lower.

A report from CoreLogic released today said that completed foreclosures edged down from 71,000 in January to 65,000 in February, and that the number of homes in a state of foreclosure has shrunk by 115,000 homes from February 2011 to 1.4 million homes in February 2012.

Despite the slight month-over-month drop, foreclosure activity has remained relatively steady recently, but economists predict that it will rise in the coming months because of the resolution of an investigation into illegal foreclosures between the government and major mortgage servicers.

Fleming told AOL Real Estate that the housing market may feel the impact of the robo-signing settlement during the summer, after the five banks involved in the settlement implement government-approved foreclosure practices.

All of this will result in more foreclosure pain in the short term as some of the foreclosures that should have happened last year instead happen this year,” Daren Blomquist, vice president of online foreclosure marketplace RealtyTrac, said in February. The economist predicts that completed foreclosures will jump by 25 percent in 2012, totaling 1 million.

But since the market must eventually absorb the excess supply of foreclosed homes, breaking the foreclosure logjam isn’t necessarily a bad thing. “I would like to see the pace increase, because that means we’ll be able to work off the inventory faster,” Fleming said. And the downward pressure on prices that’s caused by an increase in foreclosures may be mitigated by improvements observed lately in other sectors of the market, as well as the economy as a whole, he says.

Is it better to perish by fire or ice?

Withholding inventory and dragging out the collapse (the ice scenario), keeps prices higher and helps save the banks which is why lenders are doing it. However, it’s the worst possible outcome for owners. A slowly formed bottom and a decade of grinding prices leaves everyone without equity. The move-up market will be dead for the next generation.

Allowing prices to crash by clearing out the inventory through capitulation provides equity for buyers who enter at the bottom and in the years that follow. The equity from those owners ignites a move-up market and helps absorb high-end properties.

Orange County is experiencing the Ice scenario. Las Vegas is experiencing Armageddon. Which market would you prefer to be in?

Lenders may hold back the flood of foreclosures this year. They are united in their desire to prevent prices from falling further; however, as the cartel succeeds, each of its members will look at its own balance sheet and reevaluate whether they believe it’s in their best interest to continue to withhold inventory or step up their liquidations. Once the fear of falling prices is abated, he pressures to liquidate will motivate lenders to process more and more foreclosures. With the lag times in reporting, its likely they will snuff out this year’s rally and several others over the next few years. We may hit the bottom tick of the market this year, but the instability of the cartel may make this bottom as illusory as the 2009 bottom was.