The US Housing Market’s “Phantom Inventory” – OpEd

The housing market is getting better. It’s getting better all the time.

Foreclosure activity is down, sales are picking up, shadow inventory is shrinking, and prices are rising for the first time since President Obama launched his First-time Homebuyer Credit program in 2009 which juiced the market for a couple of months before demand fizzled and prices resumed their downward skid. Analysts are confident that that won’t happen again. They assure us that, “this time the recovery is real.”

Okay, but what does the data say?

It says that shadow inventory is gradually dwindling, which is a good sign since a large supply of backlog properties push down prices and discourage potential buyers. Here’s an excerpt from a recent report on shadow inventory by CoreLogic:

“CoreLogic … reported today that the current residential shadow inventory as of July 2012 fell to 2.3 million units, representing a supply of six months. This was a 10.2 percent drop from July 2011, when shadow inventory stood at 2.6 million units, which is approximately the same level the country was experiencing in March 2009. Currently, the flow of new seriously delinquent (90 days or more) loans into the shadow inventory has been roughly offset by the equal volume of distressed (short and real estate owned) sales … The decline in shadow inventory has recently moderated reflecting the lower outflow of distressed sales over the past year,” said Mark Fleming, chief economist for CoreLogic. (Calculated Risk)

No two ways about it, this is a very positive development. Shadow inventory represents the number of homes that are seriously delinquent or held by the banks but not currently listed on the Multiple Listing Services (MLSs). Analysts refer to these distressed properties as “pending supply”. In any event, the fact that the banks are whittling down their humongous backlog, is great news for the industry. It means that the market is rebalancing and things are headed in the right direction.

Sales of existing homes are also up substantially. In September, the National Association of Realtors (NAR) reported that existing home sales– which comprise 85 percent of the market–rose 7.8 percent to a seasonally adjusted annual rate of 4.82 million in August. This beat all analysts expectations. The numbers indicate that the market is being impacted by pent-up demand that could lead to sustained growth.

The latest data on housing prices is also good. According to the benchmark S&P/Case-Shiller Home Price Indices: “average home prices increased by 1.5% for the 10-City Composite and by 1.6% for the 20-City Composite in July versus June 2012. For the third consecutive month, all 20 cities and both Composites recorded positive monthly changes.”

Case-Shiller only covers the period through July 2012. A more up-to-date report from Redfin estimates an “annual price gain of 5 percent across 19 major U.S. markets”.

The news on foreclosures is the icing on the cake. Last week, RealtyTrac announced that foreclosure filings plunged to a 5-year low, dropping 16 percent year-over-year. (Foreclosure filings include default notices, scheduled foreclosure auctions and bank repossessions.)

So, like we said, foreclosure activity is down, sales are up, shadow inventory is shrinking, and prices are on the rise. Everything is just groovy in the housing market, right? At least that is the conventional view of things. But there is a different way to interpret the data, a way that makes the market look exceedingly fragile and susceptible to future price shocks.

Consider this: In September, 2011, foreclosure sales in Las Vegas represented 49.4% of total sales. In September, 2012 they slowed to a trickle of 13.6%. The same thing happened in Phoenix, where foreclosure sales in September 2011 were 37.1 %. A year later those numbers slipped to a measly 12.9%. And in Reno, more of the same; foreclosure sales clocked in at 38.0% in 2011, and then fell off a cliff in 2012. ( 12% )

Sure, some of decline in foreclosures can be attributed to the uptick in short sales, but not the lion’s share. What’s really happening is the banks are withholding many of their distressed properties in order to push prices higher and entice more buyers into the market. So far, the strategy is working, although it does appear to be hurting sales.

But didn’t we just say that existing home sales rose in August by 7.8 percent?

Indeed, but that was just a one or two month anomaly spurred by investors and all-cash buyers piling into the low-end of the market. Now that prices have adjusted, normal supply-demand dynamics should reassert themselves which means that higher prices should dampen future sales. And that’s what’s happening. (Pending sales of existing homes fell 2.6% in August)

In the areas of the country where prices are rising, sales are beginning to slip, and oftentimes this slide is quite dramatic, like in Phoenix where sales dropped a full 17.9% from a year earlier. This is because the percentage of bank owned properties (in Phoenix) dropped from 37.1% (2,931) in 2011, to just 13.6% (835) which pushed up the median home price 30.5%. When prices rise, demand will fall unless, of course, lending standards ease and the banks start loaning money to anyone who can sit upright and move a pen (like they did before).

The banks have demonstrated that they can stabilize prices by withholding distressed properties, but there will be unintended consequences, mainly, a reduction in net sales and erratic price movements. (In my own zip code, the banks policy has had a particularly shocking effect. According to Redfin’s Insider Report for September, prices are up 47% while sales are down 44%. These exaggerated figures will gradually balance out as the year goes on as they have in other markets.

So, despite all the happy talk about a housing rebound, sales are likely to be weaker than they would be if the banks put more of their distressed properties up for sale. Of course, if they dumped their real estate stockpile at a faster pace, prices would nosedive from and their balance sheets would take a thumping, which is why the charade goes on.

But why does it matter, after all, if the shadow inventory is shrinking, who cares whether the banks are dragging their feet or not?

But that’s the point, the shadow inventory is not shrinking. What’s shrinking is the number of homes that the banks have identified as seriously delinquent or that are in some stage of foreclosure but not currently listed on the MLS. There are millions of other distressed properties in mortgage modification limbo or for whom there is no paper trail, that will eventually be foreclosed. Analysts estimates of this “phantom inventory” vary wildly, but no one who follows the market closely accepts Corelogic’s 2.3 million units claptrap. For example, here’s a clip from LPS’s Mortgage Monitor report for May:

* 1,967,000 loans less than 90 days delinquent.
* 1,575,000 loans 90+ days delinquent.
* 2,027,000 loans in foreclosure process

That’s a total of 5,569,000 loans that are delinquent or in foreclosure as of May 2012. That’s a far cry from 2.3 million units. And this is a “conservative” estimate! Some experts predict that we are barely halfway through this foreclosure mess, like The Big Picture’s Barry Ritholtz who said, “We may end up with a total of 8-10 million foreclosures before we are finished.”

Corelogic’s estimates just don’t square with the facts. As we noted in an earlier article, housing expert, Keith Jurow, who has done extensive research on various housing markets across the country, started digging through the “pre-foreclosure notices” that are sent to all delinquent owner occupants in the greater New York City area and found that–of the “265,000 seriously delinquent homeowners” in NYC area, a mere 404 were listed for sale. (301 foreclosed properties on the active MLS and 103 in Brooklyn) That means the banks are sitting on roughly 264,000 distressed homes that don’t even appear in the shadow inventory figures. Chew on that for a minute. And it looks like the banks are doing the same thing in Florida, Arizona, and other hard-hit markets. The fact is, the shadow inventory is just the tip of the iceberg. The bulk of the distressed backlog is contained in a nearly invisible, phantom inventory.

Still, none of this has hurt the banks bottom line mainly because they still keep their non performing loans and funky assets on their balance sheets at fictional prices, concealing the fact that they’ve lost 30% of their value. (The banks are not required to mark their assets to current market prices.) Also, they can borrow money from the Fed at zero, so the cost of rolling over their debt is minimal. In other words, Fed policy is tailored to improve bank profitability, which is what QE3 is really all about, another giveaway to the cartel mucky-mucks. Just take a look at this from the Los Angeles Times:

“Home lending is booming. The banks said profits on the sale of home loans were twice as high as traditional levels as the Federal Reserve kept interest rates at historical lows to help stimulate the economy.

JPMorgan and Wells Fargo, which emerged from the financial crisis as two of the strongest U.S. banks, control nearly half of the nation’s mortgage volume. They reported a surge in revenue from mortgage origination and servicing during the last three months…

At Wells Fargo, mortgage business revenue rose 55% to $2.8 billion during the third quarter from $1.8 billion in the year-earlier period. The San Francisco bank posted an overall profit of $3.94 billion, which easily surpassed Wall Street projections.

JPMorgan’s mortgage business posted a 71% increase to $2.4 billion from $1.4 billion last year. This led the bank to beat expectations with an overall profit of $5.7 billion….(“Banks see a housing rebound”, Los Angeles Times)

Yipee. Profits are up 71%. QE3 must be working. But, wait a minute; wasn’t the program supposed to lower unemployment and increase GDP? Uh huh. But it doesn’t really do that, does it? In fact, it hasn’t even increased home sales. All the activity has been in refinancing where the lower rates have triggered a refi boom that’s generating windfall profits. Check this out from the Wall Street Journal:

“The Federal Reserve’s most recent bond-buying plan has sent mortgage rates to new lows. But banks’ hefty margins—often 50% above typical levels—have kept rates from falling even further.

The juicy margins can be largely attributed to constrained supply. Bank of AmericaBAC -2.36% decided late last year to pull back from part of the market. Meanwhile, others either have lacked the ability or will to significantly increase production.

That is understandable. Bulking up in mortgage origination now doesn’t make sense if the refinance wave will fade over the next year. That could simply foster the kind of loose underwriting that helped fuel last decade’s housing bubble.

Yet with housing still fragile and big banks a continued target, outsize profits may rankle politicians or regulators. That poses a risk to future results.” (“Mortgages Now Provide Shelter for Banks”, Wall Street Journal)

Really? So you think that “outsize profits” from another Fed welfare program might piss off congress? Why would that be? They must be used to getting shafted by now, don’t you think?

But what does all this have to do with housing? What we want to know is whether QE3 will push housing prices higher?

It certainly could, but at significant risk to the economy. Here’s why:

Existing home sales are presently on course for 4.8 million units this year which is slightly above trend. That’s good, right? In other words, the market has finally normalized.

So what’s the point of QE3? Why does Bernanke want to pump hundreds of billions in liquidity into a market that’s exactly where it should be right now? Why not work the other end of the problem, the “demand” side, and try to lower the burden of debt that is weighing down homeowners who need to patch their balance sheets before they can increase their spending? What’s needed is debt repudiation not asset inflation.

What the Fed chief is trying to do is create an incentive for the banks to lend money to unqualified, subprime borrowers (again) so the banks can convert the loans into MBS which they then sell to the Central Bank. This is Bernanke’s plan for rebuilding the economy, another bubble.