Tuesday, September 29, 2009
While a variety of government officials and media outlets are suggesting (if not outright proclaiming) the Great Recession to officially be over, there is still a big hurdle facing land development (both residential and commercial): the shadow inventory.
The shadow inventory is the suspected large number of homes that banks have not foreclosed on but are delinquent in their payments. Now, one might wonder why would a bank not foreclose on a property when it has a right to do so.
Well, there are a variety of reasons but two main ones stick out:
1. Because so many banks packaged and sold home loans as securities (the now infamous MBS or Mortgage Backed Security), there are serious questions as to what entity actually maintains the legal right to foreclose. Indeed, several courts are now dismissing foreclosures actions for this very reason.
What ends up happening if these convoluted contracts cannot be sorted out to identify what party/parties actually "own" the right to foreclose? That will be a topic-in-waiting for continued analysis by law review authors well into the future...
2. When a bank begins foreclosure, the loan typically moves from being an asset to a liability. While this statement simplifies the situation a bit, the basic premise is that some banks are now trying to extend the delinquency period in order to avoid having to report bad loans on the liability side of their ledger. The suspicion among several industry observers is that, if all delinquent loans were foreclosed on, several banks would be underwater at Cheney-ian levels (as in "big time").
So, there appears to be a large inventory of home loans that are not being paid by the borrower but not being foreclosed by the lender. The likely expansion of this shadow inventory is suggested by recent news from Fannie Mae of a spike in loans that qualify as being seriously delinquent (read more on the report at the excellent Calculated Risk blog).
Even more concerning is that these loans are not the troubled subprime or OptionARM versions but typically conventional mortgages--you know, the ones that were supposed to be most reliable and safe from failure.
The result of all of this is that we are unlikely to see any significant or sustained increase in land development (especially residential homes) until this shadow inventory is disclosed and drawn down.