S&P: Shadow Inventory Still a Concern. Reason to Extend Fed’s MBS Program?

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

Noting that thernCase Shiller/S&P Home Index had risen 3 percent since hitting its low inrnMay of last year, today's report speculated that the increase may have been thernresult of the temporary reduction in foreclosures while loan modification programsrnwere getting off of the ground. However, it says that many servicers havernnearly run out of plausible candidates for loan modifications and will findrnthat many loans cannot be salvaged.

WhatrnS&P calls a “shadow inventory” may take as much as 33 months tornclear at the current sales rate.  This isrna conservative estimate according to S&P as it includes only those loansrnthat are currently delinquent and does not take into account current andrnperforming loans that may get into trouble in the months ahead.  This increased inventory indicates that homernprices may fall again.  An S&Prnspokesperson said that loan servicers are increasingly looking to short salesrnas a solution.

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

The Journal said that two studies, one conducted forrnJohn Burns Real Estate Consulting, Inc. and the second by Standard & PoorsrnFinancial Services, LLC, anticipate that a large percentage of currentlyrndelinquent mortgages will eventually be foreclosed, painting a picture ofrncontinued excess inventory and a renewed downward pressure on housing prices.

The Burns study estimates that, of the estimated 7.7 millionrnhome loans that are currently delinquent, about 5 million will eventually bernforeclosed or otherwise forced onto the market over the next few years.  These homes would add to the already largerninventory of homes listed for sale, especially in four states that have beenrnespecially foreclosure-plagued.  The reportrnnames five cities in the Nevada, Arizona, California, and Florida where, ifrnBurns estimates are correct, there could be backlogs of homes that would takern15 to 27 months to absorb. The increased national inventory would require 10rnmonths to sell.  At the end of DecemberrnFHA put the current national inventory at an eight months supply and falling.  

The Burns report also quotes the S&P/Case-Shiller indexrnand also attributes the recent rise in prices to foreclosure prevention efforts andrnalso to a strong investor appetite for foreclosed properties. That report,rnhowever, projected fairly stable prices despite rising inventories unless therernis a second recessionary slump or interest rates rise.

At the end of December servicers participating in thernTreasury Department's Making Home Ownership Affordable (HAMP) program reportedrnthat about 3.4 million residential loans in their portfolios were 60 days orrnmore delinquent.  About 900,000 of thosernare enrolled in trial modification programs, but as we have reported a numberrnof times, the few permanent modifications arising from these trials – about 66,000rnby the end of December – are a cause of serious concern. 

Another FHA report issued in January showedrnthat the rescission rate on Fannie Mae and Freddie Mac's loan modificationrnefforts was around 60 percent.  Whilernthere had been some marginal improvements in the rate of re-defaults among morernrecent modifications, taken together the two reports give some credence to therntwo 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 of “shadow inventory” being dumped on the market all once by banks, we must be respectful of the effects that unsuccesful loan modifications could have on the housing market. A spike in housing supply, for any reason, would be detrimental to the marginal stabilization and progress that was been 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 itrnimply some key element of the housing market equation was too weak tornbe 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 thernbiggest reason for business in 2009, but that won't be the case in 2010.rnThose borrowers, the ones who qualify, already took advantage of lowrnrates. Originators will need a new source of business in 2010.rnPurchases are the immediate loan type that comes to mind.

If the purchase market fails, it wont be the fault of highrnmortgage rates. It will be the result of a lack of credit worthyrnborrowers. 

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

Damaged consumer credit profiles need timernfor repair. This means a stable jobrnwill be required to ensure consistent payments are made and credit is properly mended. After that, total debt service payment can't bernover 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 an extension of the Fed 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!

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