Tuesday, May 15, 2012

Upon Further Review: a residential housing market with shadow market of foreclosures -or- a total eclipse of foreclosures?

John B. Taylor in his book Getting Off Track : How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis makes the grand observation that the financial crisis was a government lead failure. That government policy, or more succinctly politico policy, set the stage for shenanigans that occurred in the private sector leading to the financial crisis. (1)

Morgenson and Rosner in their book Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon write a detailed account, stretching back decades, and names-names regarding politico policy and the actors that set the stage for shenanigans. (2)

In an essay entitled Upside Down Economics Thomas Sowell writes a concise time line regarding politico policy setting the stage for shenanigans. (3)

M. Jay Wells essay Why the Mortgage Crisis Happened also provides a very good chronological history of politico policy from 1933 to 2008 which set the stage for shenanigans. (4)

Regardless of history and empirical study, certain individuals want to notionally blame the private sector or the market or banks for the financial melt down when in fact the case is politico failure of the first degree. The “market failure” mantra regarding the financial crisis is, of course, carried forward and lauded by politicos themselves to deflect the true case of politico failure.

One then arrives at today’s aftermath, a murky quagmire of residential home values falling and few new homes being built, a deflationary spiral of value if you will. The declining values fueled, in part, by abundant foreclosures with a pipeline full of foreclosures yet to come to market. One might find that the shadow inventory of foreclosures yet to come to market, depicted as a “pipeline”, may well be much bigger than advertised. How so?

Roger Arnold, chief economist for ALM Advisors, writes in an essay entitled U.S. Housing Market Cannot Recover:

“The most important issues to consider are:


How many foreclosures have there been?
How many more will there be?
What do the banks plan to do with them?

Properties received by banks through the process of foreclosure are carried and accounted for as Other Real Estate Owned (OREO). The three primary categories of OREO are 1-4 Unit Residential, Commercial, and Construction and Development.

In this column, I will only address 1-4 Unit Residential properties, which represent 25% of all OREO at U.S. banks. I will discuss the others in future column or in the comments section below if readers are interested.

There are about 7,000 banks in the U.S. and OREO affects all of them. The principal value of mortgages tied to the OREO at the four largest institutions, JPMorgan Chase(
JPM_), Bank of America(BAC_), Citigroup(C_), and Wells Fargo(WFC_) is much lower as a percentage of outstanding loans than at the smaller institutions below them. This is because the smaller banks have foreclosed on non-performing mortgages while the larger institutions have not.

The result of this is that the outstanding value of non-performing mortgages held by the four largest money centers are much higher than at the smaller banks. The money centers have simply not been foreclosing.

The value of the loans attached to OREO, the properties already foreclosed on by the four largest money centers, is only 3% of the value of the non-performing loans they hold; the properties that have yet to be foreclosed on but most probably will be.

The 97% of mortgage loans that have not been foreclosed on but probably will be makes up the largest percentage of what is known as shadow inventory. This number is so horrifically high that even the pundits aware of the issue won't discuss it publicly -- probably because their own livelihoods could be at stake for doing so.” (5)

Arnold goes on to make this statement:

“Just think of the damage that has been done to the housing sector, as well as the national and global economies and financial markets, with only 3% of the probable foreclosures required as a result of the U.S. housing crash having been completed to date.” (6)

Hence the pipeline of foreclosures on their way to market is nothing in comparison to the reservoir of foreclosures feeding the pipeline. Hence it’s not so much a shadow inventory of foreclosures as it is a total eclipse of an inventory.


(1) John B. Taylor, Getting Off Track : How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis.


(2) Morgenson and Rosner, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon.


(3) Upside Down Economics, Thomas Sowell.


(4) M. Jay Wells essay Why the Mortgage Crisis Happened.


(5) U.S. Housing Market Cannot Recover, Roger Arnold




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