Real Estate Inventory Overflow Threatens Housing Recovery

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If you had a crystal ball and could look into the future you could probably answer the question as to how many more foreclosures will happen in the U.S. Since economists don't have that magic ball, they're trying to calculate not only the current shadow inventory (those homes already foreclosed, but not on the market), but also the "shadow" shadow inventory (those homes yet to enter foreclosure).

The "shadow" shadow inventory is purely speculative because it looks not only at those homeowners now delinquent, but also those whose homes are underwater (and who may walk away), as well as those who lose a job and end up in foreclosure. So you shouldn't take any bets on the "shadow" shadow inventory just yet.

Trends shown in the recent Mortgage Bankers National Delinquency survey indicate both good news and bad news. The MBA found decreases in the number of foreclosure starts. Also, there's a drop in the inventory of homes that are at some point of the foreclosure process. In fact, the MBA's chief economist, Jay Brinkmann, said: "The fact that both the 90-plus delinquency rate fell and the foreclosure-start rate fell means that a significant number of these seriously delinquent loans have been successfully modified and reclassified as performing, current loans."

So maybe the modifications are working out better than expected and the number of homes yet to enter foreclosure are not as high as the pessimists predicted.


On the side of the most pessimistic is Morgan Stanley's securitized credit department. Since they are advising investors in the purchase of securitized mortgages, you can be sure that they are hedging their bets for the worst-case scenario. In their recent report, "U.S. Housing Strategy: The Long Road Home," the analysts predicted that home prices will stay low "for another three to four years, during which annual appreciation may reach only as high as inflation or income growth." So they think we've yet to see a 5 to 10 percent decline in housing prices, which would throw even more people underwater and at risk of entering foreclosure or just walking away. Also on the side of the pessimists is Deutsche Bank, which predicts 20 million homes will be underwater by the end of 2011. The most recent report from CoreLogic puts that number at 11 million right now.

While most people who put a number on the shadow inventory say that there are about 4 million to 5 million foreclosed homes that have yet to reach the market, Morgan Stanley predicts that it could be as high as 8 million, which would take 47 months to clear out. Barclays Capital expects the peak at 4.7 million this summer. Capital Economists thinks we won't see the peak until the end of 2011, when it will reach 5.5 million.

But no one really knows because the big question is: What will happen to employment? Whether or not the future news will be good or bad depends entirely on the employment picture.
"Ultimately the housing story, whether it is delinquencies, homes sales or housing starts, is an employment story," the MBA's Brinkmann says. "Only when we see a consistent increase in employment will we see an increase in sales and starts, and a sustained improvement in the delinquency numbers. Until we see the increase in the number of households that comes with an increase in the number of paychecks, all measures of the health of the housing industry will continue to be weak."

So don't go out there taking bets on the shadow inventory until you get a clear picture of which way the employment trends will head. If we're heading back into a double-dip recession, you can count on more layoffs and a jump in foreclosures. But if employment growth trends are seen, then we're likely at the bottom of the delinquency trends.

Lita Epstein has written more than 25 books including "The 250 Questions Everyone Should Ask About Buying Foreclosures."


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