Why housing bears are probably wrong about the impact of “shadow inventory”Posted: October 19, 2009
According to housing bears, banks are withholding from the market a “shadow inventory” of millions of foreclosed homes. When these houses are put up for sale, the argument goes, the supply of foreclosed homes will overwhelm demand, resulting in another crash in housing prices. As my favorite housing bear David Rosenberg put it,
“the supply data have been distorted in part because of all the inventory that has been held off the market on bank balance sheets, but this cannot last forever. Estimates we have seen, peg the “shadow” inventory at 7 million housing units — those in foreclosure, those just entering the process, and those that have been in arrears for the past year but have yet to receive a notice. Tack these on to the “official” unsold inventory count of 3.6 million and what we are talking about is an overhang equivalent to 25 months’ supply. It is truly hard to believe that home prices are doing anything more than a wiggle right now in a long-term downtrend…”
Now, Mr. Rosenberg is a smart cookie. There is no question he is right about there being large numbers of foreclosures are in the pipeline, and there is no question that this will put downward pressure on housing prices (or, rather, limit price appreciation). Nonetheless, there are a couple of problems with the bearish “shadow inventory” argument.
To start with: According to the latest foreclosureradar.com report, there is no shadow inventory of bank-owned homes being intentionally withheld from the market. On the contrary, banks have dramatically reduced their inventory of foreclosed homes. (See, e.g., Sacramento.) So when we talk about “shadow inventory” we are really talking about homes that are in the early stages of foreclosure or have not yet been foreclosed on, such as (in Rosenberg’s words) “homes that have been in arrears for the past year but have yet to receive a notice.”
But such homes aren’t likely to flood the market in the the next few months. Instead, they will probably dribble out onto the market over a period of years, greatly reducing market disruptions. (Keep in mind that demand for foreclosures is very, very strong.) Why are we looking at a period of years rather than months before these houses hit the market?
1) Massive amounts of foreclosures are clogging up civil courts in post-bubble cities, tripling the amount of time it takes to to move from initial filing to final judgment and auction.
2) Recent judicial rulings will likely slow down the foreclosure process. According to the Kansas City Business Journal, a late August ruling by the Kansas Supreme Court “undercut the business model for one of the mortgage industry’s key players — an intermediary that monitors mortgage sales and transfers for mortgage holders — saying the company lacked legal standing to receive notification of a home foreclosure in a case coming from Ford County in Southwest Kansas.” Details here.
The Boston Globe reports that a separate ruling by a Massachusetts Land Court justice late last week puts into question the ownership of hundreds — and possibly thousands — of foreclosed properties in Massachusetts.
If we believe the most bearish estimate, the “shadow inventory” in the U.S. consists of 7 million homes. Let us assume, for the sake of argument, that every one of those homes ends up in foreclsoure and is placed on the market. Let us assume, further, that because courts are clogged and because banks have difficulty proving ownership, it takes about two years for this to occur. (Keep in mind we are talking about homes that are either in the early stages of foreclosure or that have not yet entered the foreclosure process.) If 7 million foreclosed homes hit the market over a period of two years, that would mean an average of 875,000 foreclosures per quarter for each of the next 8 quarters. By comparison, a total of 937,840 homes received a default or auction notice or were repossessed by banks in the third quarter of 2009.
The “shadow inventory” is certainly a problem for the housing market, but it is not necessarily an unprecedented or insurmountable one. The weight of evidence suggests that the long-term downward trend in housing prices is over.