Why the ‘Wave’ of Foreclosure Listings Might Never Happen

By Nick Timiraos, Wall Street Journal - August 21st, 2009

For weeks, even months, real-estate professionals have been asking the same question: when will the so-called shadow inventory of homes in the process of foreclosure finally hit the market?

Most mortgage servicers ended a foreclosure moratorium in March, and pre-foreclosure filings have accelerated since then, even as the supply of bank-owned properties in some markets has dwindled.

But what if that wave of foreclosures never hits the market? “For those of you still waiting for a surge of foreclosure sales, the truth is you’ll likely be waiting a long time,” writes Sean O’Toole, the founder of ForeclosureRadar.com, which tracks foreclosure filings in California. He breaks down his argument at his blog in this pithy post here.

For one, the time between a mortgage default and a foreclosure listing has grown longer as more homeowners try to complete loan modifications or short sales. Banks aren’t likely to cancel foreclosures even if they put a borrower into a trial modification. Instead, they’ll simply keep the opportunity to foreclose in case the loan modification fails.

One clue that modifications will work: cancellations of foreclosure auctions. So far, cancellations are up slightly, Mr. O’Toole says, but not enough to explain the yawning gap between mortgage defaults and bank-owned listings.

One possibility: foreclosures will simply stay at an elevated level for the next couple years, he says, but there won’t be a huge wave of inventory added all at once. For now, California is seeing a housing inventory shortage, in part because short sales are still hard to execute. Many homeowners are underwater and can’t sell, and those who can don’t want to put their homes on the market if they’re looking at a big loss.

Mr. O’Toole has done some interesting analysis that shows just how profound government policies may have been in encouraging banks to slow down foreclosures. His argument: When the U.S. last September began purchasing direct obligations of government-sponsored mortgage companies, and later began buying mortgage-backed securities that sent a message to banks that they didn’t need to refill empty cash cushions by foreclosing. Policymakers also changed accounting rules so that banks wouldn’t have to take as severe writedowns.

While the raw data suggests that foreclosures should be increasing, it’s harder to predict because “there’s so much government middling into this process,” Mr. O’Toole told the Developments blog. “When you have this much government intervention going on, things don’t necessarily proceed as they should.” (See our earlier post this week on the topic.)

As for the idea that banks are deliberately holding onto foreclosed homes? Mr. O’Toole shoots that idea down too, with a quick back-of-the-envelope sketch that shows that while the gap between bank repossessions and foreclosure sales stands at around 90,000 in California, the actual shadow inventory is probably closer to 22,500.

Readers, what do you think: is the shadow inventory just a Realtor pipe dream?