Shadow Foreclosures

[Nick Tang]

By Marc Atkins

Mention the economy, especially the housing crisis, and you are likely to get a barrage of strong and often conflicting opinions. The current consensus among financial analysts and other talking heads is one of at least cautious optimism. They point to gains in the stock market, GDP growth, slowing unemployment, and what is often touted as evidence of a bottom in housing prices. But there is growing concern over so-called “shadow foreclosures”, creating a “shadow inventory” in housing markets.

Simply put, due to lags in the foreclosure process, the number of foreclosed homes for sale on the open market, while reaching new heights, is comparatively low, based on the number of homes that are or should be entering foreclosure. The Washington Examiner recently reported that in June of 2009, more than 50,000 mortgages were more than 90 days past due in the Washington area. Last year, ABC15, in Phoenix, Arizona quoted a RealtyTrac study of 4 real estate markets, finding that more than 70 percent of homes going into foreclosure were not entering the market. And a recent article posted to Boston.com cites Bank of America’s recently announced plans to place foreclosed homes in the state of Nevada on the market at a rate of 500 per month. This represents a nightmare scenario for many analysts and real estate professionals. Foreclosed homes can sell at typical discounts of 10 to 50 percent, according to a Wall Street Journal article in September of last year, in which real estate consultant John Burns states, “There’s going to be a flood [of bank-owned homes] listed for sale at some point”.

With employment numbers still lagging and many buyers finding it difficult to get financing, a sudden glut of REO’s for sale could spell opportunity for some and disaster for others. Homeowners looking to sell are already competing in a slender pool of qualified buyers. While opportunistic investors might welcome an increased inventory which would undoubtedly lower prices even further, others worry that the ”shadow inventory” threatens the struggling economic recovery, especially in the housing market.

What accounts for this threat is the subject of debate. One explanation is that banks are simply overwhelmed by the volume of foreclosures and the amount of paperwork involved in processing them. Any investor familiar with the foreclosure process knows how tedious and drawn out it can be. Departments handling REO’s and foreclosures are often over-worked and under-staffed. In this respect, a deluge of new REO’s might not bode well, even for investors.

Further complicating matters are issues concerning tenants. Many places, including, Los Angeles, Chicago, New York and New Jersey, have Just Cause Eviction Controls; laws protecting renters from evictions, including those by a foreclosing bank. In a recent post to www.reotenants.com, the author, identified only as Robert, says, “Clearly, an inability to evict tenants from REO properties and an unwillingness to sell REO properties with tenants still in them is making it harder for banks to move their inventory”.

Some are also blaming the Obama administration’s loan modification efforts. The Boston.com article cites comments made by John Ciresi, a Bank of America portfolio manager, at an industry conference. Mr. Ciresi blamed the foreclosure backlog on banks’ “attempt[ing] to work things out with struggling homeowners, which along with a myriad of temporary foreclosure moratoriums imposed by different states, has helped create the giant overhang.”

There are opposing viewpoints even among those who agree that banks are intentionally slowing down the foreclosure process and the resale of properties. One side believes the banks are motivated purely by profit, manipulating both their balance sheets and the market. Until the asset is sold at a loss, a bank is not required to report its lower value. “They do not want to show losses, so they are holding properties in the shadows”, says John Bancey, a Kenilworth, NJ realtor with Realty Executives. “The Wall Street rating they have is very important to them. This affects their ability to leverage anything, and their stocks.” Bancey also points to the role of secondary markets. “The bank sold the note to a corporation a long time ago, so it’s a business and very lucrative. They will not have any interest in helping the home owner.”

But others see the holding back of inventory as beneficial to the economy, even if the banks are operating solely in their own best interests. Spreading foreclosures out over a longer period of time, they argue, will allow new buyers to enter the market, while flooding the market with the huge inventory banks now hold would drive prices down drastically. In a post to the blogsite, LoanWorkout.org, Moe Bedard writes, “I feel it is unfair to the millions of homeowners who are trying to sell their homes and have to compete against these banks and these huge inventories.” In a later post, Bedard also acknowledges the advantage this strategy holds for the banks. “The purpose is to stabilize home values by releasing inventory and controlling what comes on the market and when. Thus banks can be in the real estate game in a big way during the recovery.”