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A shadow lurks in the housing market

This is scary. The San Francisco Chronicle reports that lenders are sitting on hundreds of thousands of foreclosed homes that haven't even been listed yet. If this "shadow inventory" hits the market, we'll have a new definition of bottomless pit.

From the article:

"We believe there are in the neighborhood of 600,000 properties nationwide that banks have repossessed but not put on the market," said Rick Sharga, vice president of RealtyTrac, which compiles nationwide statistics on foreclosures. "California probably represents 80,000 of those homes. It could be disastrous if the banks suddenly flooded the market with those distressed properties. You'd have further depreciation and carnage."

The Chronicle suggests several reasons why banks might not be selling off their foreclosures:

-- The "pig in the python": Digesting all those foreclosures takes awhile. It's time-consuming to get a home vacant, clean and ready for sale. "The system is overwhelmed by the volume," Sharga said. "In a normal market, there are 160,000 (foreclosures for sale nationwide) over the course of a year. Right now, there are about 80,000 every month."

-- Accounting sleight-of-hand: Lenders could be deferring sales to put off having to acknowledge the actual extent of their loss. "With banks in the stress they're in, I don't think they're anxious to show losses in assets on their balance sheets," O'Toole said.

-- Slowing the free-fall: Banks might be strategically holding back some foreclosures so prices don't fall as fast. "They want to be careful about not releasing them too quickly so they don't drive prices down and hurt the values," O'Toole said.

And then, there are people scamming the system. Two dozen people have been indicted for "allegedly conducting a wide-ranging mortgage fraud based in San Diego and led by a street gang member." From Reuters:

The defendants allegedly used straw buyers and inflated appraisals to purchase homes that had sat on the market for extended periods and had been reduced in price.

They submitted offers that exceeded the homes' asking prices, and had the overage paid to a shell construction company that they claimed would make upgrades or handicap modifications to the properties, prosecutors said.

The defendants instead disbursed the "kickback amount" to members and associates of the enterprise as payments for their participation, the indictment said.

Lenders later foreclosed on the properties, taking "severe financial losses," after the straw buyers failed to make payments, the indictment said.

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Sorry, this was supposed to go in response to John H's comments below. Apologies.

Lou,

I will spare you the explanation of why bad for the economy is bad for every one.

But do me a favor. Spare us the generalization "The only people who get hurt are the irresponsible to over-leveraged themselves."

In this times a lot of responsible people are getting hurt too. If you don't know that, maybe you should get out and talk to some workers who lost their jobs because of the economy.

If a person was responsible, then they would have bought affordable house with fixed mortgage. If they gambled with ARM, that is not responsible.

As to recessions, they happen all the time. That is the reason you need to have emergency fund to be able to survive recessions. Otherwise they should not have bought the house.

What about folks who DID have savings, and they invested it in what they were told was a low-risk "high-yield" savings account based on AA-bonds - Only to discover that the rating agencies lied to them and the result was that they lost 80% of their savings?

This is true, happened to a co-worker of mine. Her broker told her she was in a low-risk savings that was earning something like 6%. She did reasearch and determined that the level of risk was at most likely to be maybe a 15% loss based on the rating.

In fact she lost nearly 80% of it in about a month (I think it was August 2007) I remember hearing her crying on the phone to her broker several pods away from me. The losses amounted to over 14,000. She was about 28 years old.

Dude, there are always fraud cases. In this case the regulators (SEC) and congress failed. This has nothing to do with housing market. If the regulators did their work then your friend would not have lost the money.

Except for tresuries (because treasury with FED owns printing press) there is always risk. Also never believe the rating agencies. They are run by same crooks that run wall street banks. They care about their bonuses next quarter and this year. That is farthest they think into future.

gb:

You were the one that tried to pin the blame on people being irresponsible. All I was trying to say was that there were a lot of people who did try to be responsible who got caught up in the mess. That's a fact, dude.

Disastrous for whom? If the markets were flooded with all of the inventory what would it mean? New housing starts are about as close to zero as they can be. Maybe it could hurt median home prices in some markets? But we've already seen big drops in those with sales volume increasing. Maybe this isn't a disaster so much as a sign that we shouldn't expect new housing starts to see any big gains anytime soon.

Ned makes a good point. The banks seem to believe that the pre-crisis level of house prices was reasonable and will inevitably return, when everyone acknowledges it was a bubble.

Even if housing starts pick up, the new houses are unlikely to be affordable for most people who are renting or homeless now. The existing stock is needed to house displaced and economically distressed people, and the sooner the better. That means banks will have to take a hit. They can't play this shell game forever. The market just won't support it.

Why don't the banks rent out these bereft homes for goodness sake, and hire property management companies to look after them?

John H

So the idea to artificially create jobs that should not exist. Why don't we pay people to build hydro-electric dams using only spoons? That will put some people to work, for sure.

I think I have to agree with John. While I like the idea of the government "priming the pump" in a recession, I don't like the way they go about it and I don't think the current stimulus package does much over the long term. 90% of the money spent is designed to inject money into the economy short-term.

We learned in the 1930s that just building roads and bridges doesn't rebuild an economy. I was not until WW II when some of the the massive government spending associated with the war actually went into research and development of technolgoies and the expansion of economic production that the depression ended.

The war spending was different than FDR's spending in several key ways: 1. It increased natural resources production (oil/steel/nitrates/, etc) 2. It boosted R&D and forwarded technologies (communciation/chemicals/electronics/avionics/ machining, etc.)
3. After the war spending on the marshall plan created an export market for US goods
4. After the war the GI Bill and housing subsidies for GI's increased the productivity of the workforce and creatsd jobs for housing.

I don't see much in the current stimulus bill that does those kinds of things.

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