Tuesday, September 29, 2009

More on the Shadow Inventory

WHAT HELPED RATTLE THE market last week was evidence that housing, which, when it crashed and burned, badly torched the rest of the economy as well, still faces a long, tough slog in its struggle to reach solid footing. It must really have pained the folks at the National Association of Realtors, who come hell or high water remain congenital optimists (you think it's easy peddling the illusion that every shack's a castle?) to report that sales of existing homes in August were lower.

The decline hurt all the more because the 2.7% drop to a 5.1 million annual rate broke a winning streak stretching back to March (which, perhaps not coincidentally, was when this explosive bear-market rally in equities began). As usual, economists, analysts and assorted camp followers had been confidently predicting a rise in sales. As usual, too, when, instead, sales fell, the economists, analysts et al. lickety-split hurried to point out that one month doesn't necessarily constitute a trend. And it doesn't, although on Wall Street that axiom somehow only applies when the month in question is a bummer.

All of which is preface to sharing with you a decidedly negative take on the outlook for housing by Amherst Securities Group, whose stuff we've quoted before and whose analysis is invariably first-rate. The report, dated last Wednesday, festooned with gory detail, focuses on the swollen overhang, the so-called shadow inventory, that has grown inexorably in the wake of the tsunami of default and foreclosure.

Amherst estimates this massive overhang at seven million units. That's the equivalent of 135% of a full year's existing-home sales and chillingly greater than the 1.27 million units that made up the overhang in early 2005, when the housing bubble had just begun its dizzying and more than a little lunatic ascent.

Put another way, of the 56 million units that the Mortgage Bankers Association says make up the mortgage universe, Amherst gauges 6.94 million units are in what it dubs the "delinquency pipeline" eventually headed for liquidation. And it reckons that another 300,000 mortgages replenish that unwelcome flow every month.

Essentially, then, this shadow inventory represents a massive furtive supply of future foreclosure. Amherst fingers negative equity as keeping the delinquency pipeline heavily stocked. Quite a reasonable assumption, we think. A home owner, saddled with a house that's valued at less than it cost him to buy or that he can reasonably expect to sell it for may lack the will and, more importantly, the wherewithal to keep making payments on his mortgage.

Homeowners' equity has declined from 58.7% back in '05 to around 43% today. What's more, nearly a third of households have no mortgages, which, of course, means that the equity percentage of the 50-plus million that do have mortgage loans is a good cut lower than 43%.

The failure of mortgage modification programs to address negative equity is why Amherst is skeptical that such efforts will be of much help in shrinking that huge shadow inventory. That's a view articulated more than once in this space by Mark Hanson, of Hanson Advisors, who, to his credit, has been quite cautionary about the prevailing bullishness on housing.

Three factors are cited by Amherst as the chief culprits in this sorry narrative. The first is the rapidity with which what it describes as the nonperforming bucket (where the mortgages are at least 60 days delinquent) is filling. The second is the strikingly low "cure rate" on delinquent loans. In 2005, homeowners retrieved 66% of their loans delinquent 60 days or longer. That percentage shriveled to a paltry 5% in the second quarter of '09.

And, finally, bloating the inventory overhang is the lengthening time between delinquency and liquidation. Of the loans in the delinquent pipeline in August 2009, 9% have not made a payment in over 24 months, compared with 4% in 2008. The reasons cited by Amherst for this stretching out include moratoriums on foreclosures and the slow pace of the judicial process in states where a judge's O.K. is required for foreclosure.

We lack the space to offer more than a sketchy précis of the Amherst analysis, which earns high marks for its painstaking explanation of how it reached its less-than- cheerful conclusions. Amherst freely acknowledges that it has emphasized the negative and ignored some positive elements in the housing picture, such as restored housing affordability and the lure of the tax credit for first-time home buyers.

But it reiterates its belief that the humongous overhang is the biggest impediment to a real recovery in housing. And it's deeply concerned that the apparent stabilization "is temporary, based on seasonal factors, and prices can deteriorate further." Any permanent improvement, Amherst contends, isn't in the cards until there's "some resolution of the shadow inventory."