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Shadow Inventory

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Shadow Inventory

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Definition: The shadow inventory counts the houses that are in some stage of foreclosure, but have not yet reached the market. CoreLogic defines it as the number of distressed properties not currently listed that are seriously delinquent (90 days or more), in foreclosure and owned by lenders. It does not include homes that are behind on payments, but the bank hasn't begun foreclosure procedures. The shadow inventory is somewhere in the foreclosure pipeline, and so must be added to unsold homes that are listed as for sale.

There are widely different estimates of how many homes are in the shadow inventory -- anywhere from 1.7-7 million. CoreLogic estimates there were 1.6 million homes, or nine months of supply, as of October 2011. This is down slightly from 2 million units a year earlier. This shadow inventory could keep housing prices flat for anywhere from one to three years. Investors are reluctant to buy homes now, knowing the shadow inventory is hanging out there. They will wait until these foreclosed homes are absorbed, and prices have a better chance of rising sooner.

The shadow inventory is in addition to the real inventory of unsold homes. This was around 4 million homes as of September 2011. At current rates of sales, this is an 8.5 month supply. Another 250,000 homes are added to the shadow inventory each month. Unfortunately, government programs haven't yet made a dent in the shadow inventory. A two year glut of unsold homes and shadow inventory probably means housing prices will stay flat unless the Federal government really focuses a whole lot more on this problem.

What Can Be Done to Reduce the Shadow Inventory?

Why has the government virtually ignored this looming threat? They may not know what to do. PIMCO fund manager Bill Gross suggested using government funds to turn all 5-7% mortgages into 4% mortgages. He said this would lift housing prices 5-10%.

So far, most initiatives haven't worked to fundamentally stem the foreclosure tidal wave. The HARP (Homeowner Affordable Refinance Program) was introduced in April 2009. It allowed the 2 million credit-worthy homeowners who were upside-down in their homes to refinance with today's lower mortgage rates. Unfortunately, only 810,00 homeowners have been helped. Why? Banks cherry-picked the best applicants.

The Treasury Department launched Making Homes Affordable in 2009. It works with banks to help homeowners modify their loans before they go into foreclosure. Unfortunately, banks only modify the payments, not the principal. Since so many homeowners owe twice as much on their mortgage as the home is worth, many who are struggling realize it's pointless to struggle to make payments with little hope of a decent return on their investment.

The Federal Reserve has a consumer help web site, and one to help community leaders assess and address problem areas. The Fed is also keeping interest rates low and continuing to buy toxic debt from banks. However, this also hasn't addressed the root of the foreclosure problem for homeowners.

Amazingly enough, some legislators have suggested things that will only worsen the problem. Some have suggested abolishing Fannie Mae and Freddie Mac. This would be a disaster, since their loan guarantees are required before a bank will even look at a loan. Before the financial crisis, they guaranteed 50% of all mortgages. Now, it's 90%. Second, the Dodd-Frank Reform Act required a 20% downpayment on all mortgages. This should not go into effect until housing is fully recovered. According to the National Association of Realtors, only 40% of recent homebuyers could even afford a 20% down payment.(Article updated December 27, 2011)

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