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Shadow Inventory: It’s Not as Scary as It Looks

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  • William Matz | | 15 Aug 2012, 06:34 PM Agree 0
    (also posted to WSJ)

    While it is true that shadow inventory is down, it would have been helpful to examine why it is down. A general statement that there are other risk factors leaves a rather incomplete picture.

    The biggest factor reducing the shadow inventory has been the slowdown in foreclosures during the 18 months the attorney general investigation was pending. Now that it is concluded in the toothless settlement, foreclosures are predicted to rise by 25%

    There are many other risk factors that must be considered:
    1. Amherst Securities Group predicted that Option ARM foreclosures would not peak until Sept 2012. And that was before the AG investigation slowdown.
    2. There are many 3/1, 5/1, 7/1, and 10/1 ARMs that will be going adjustable and - often - going from interest-only payments to fully-amortizing. Similarly, many of the mortgage mods only fixed the initial rates for five years, and increases are starting.
    3. Similarly, billions in HELOCs are going from interest only to fully-amortizing, with remaining terms of as little as ten years, causing a huge jump in payments.
    4. Much of the hi LTV lending over the last four years has been FHA; the most recent estimate is that 40% of recent FHA will default.
    5. The broader economic picture is still very tenuous. Employment, as FLS noted is low. The euro crisis, Asian slowdown, and Middle East turmoil all have the potential to disrupt any recovery and cause recession.
    6. The looming "fiscal cliff" will push the US into recession per Bernanke unless a frozen Congress and President act.
    7. Rising interest rates, coupled with the Fed having shot its last arrows limits response options.
    8. Much of the commentary about rising prices is dangerously misleading because the basis is the use of median prices. Median prices can never show price movement because median houses are different during each period. So any comparison is apples to oranges. Recent "moves" in the median have created a mirage of rising prices simply because there has been less activity in the lower end REO/distress range, causing the median (middle of the market) to "move" up. But that does not tell us whether prices are going up or down.

    Of course every market is different. But right now I believe the single biggest factor is the level of confidence in the economy. Lack of confidence will deter purchases and encourage defaults. And the impact of those psychological factors cannot be accurately measured. But it is obvious that there is much more potential for negative shocks (e.g. Iran, euro crash) than positive shocks. So until the bulk of the world economy begins to rebound on a sustainable basis, we will muddle along on the edge of the economic stall curve.
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