by Calculated Risk on 9/24/2009 11:54:00 AM

First, on the "shadow inventory" from Bloomberg: Housing Crash to Resume on 7 Million Foreclosures, Amherst Says

The crash in U.S. home prices will probably resume because about 7 million properties that are likely to be seized by lenders have yet to hit the market, Amherst Securities Group LP analysts said.

The “huge shadow inventory,” reflecting mortgages already being foreclosed upon or now delinquent and likely to be, compares with 1.27 million in 2005, the analysts led by Laurie Goodman wrote today in a report. Assuming no other homes are on the market, it would take 1.35 years to sell the properties based on the current pace of existing-home sales, they said.
...
“The favorable seasonals will disappear over the coming months, and the reality of a 7 million-unit housing overhang is likely to set in,” they said.

The report suggests that modifications might help - but not much. From the report:

We don’t think they can help significantly. The 12-month recidivism rate on modifications has historically been about 70%. ... We have argued ... that HAMP modifications are unlikely to be successful in the long run as it does not address negative equity, the single most important determinant of default. And the borrower will still face payment shock as the payments begins to ramp up after the 5 year period in which the payments are fixed.

Let’s say we are wrong and the HAMP modifications work much better than older style modifications. How much of the 7 million unit overhang can be cured by modification? The answer is “not much.”

The analysts estimate the overhang could be reduced by about 1 million units if the modifications are more successful than historical modifications.

However HAMP could spread out the flow of this shadow inventory over several years. So the size of the wave of more inventory is uncertain.

On the timing, from the WSJ yesterday:

"There's going to be a flood [of bank-owned homes] listed for sale at some point," says John Burns, a real-estate consultant based in Irvine, Calif.
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"We are going to see a spike from now to the end of the year in foreclosures as we take people out of the running" for a loan modification or other alternatives, says a Bank of America Corp. spokeswoman. Foreclosure sales had dropped to "abnormally low" levels in response to government efforts to stem foreclosures, she adds.

I think the 7 million estimate is probably high (that is HUGE), but there is definitely a large shadow inventory for the existing home market - so keep that in mind when looking at the following graphs:

Click on graph for larger image in new window.

Here is another graph of inventory. This graph shows inventory since 2002 by year.

The dotted lines (2002 - 2004) are for the boom years. 2005 (dashed green) is the transition year at the end of the boom. And the solid colors are for the bust years.

Inventory levels in August were below the levels of 2006.

The second graph shows months of supply for the same years.

"Months of supply" is lower than in 2007 and 2008, but higher than in 2006 since sales are lower. The level is still high.

The third graph shows the year-over-year change in existing home inventory.

In general prices would probably continue to fall until the months of supply reaches more normal levels (closer to 6 months compared to the current 8.5 months).

Without the huge overhang of shadow inventory, this general trend of declining year-over-year inventory levels would be considered a strong positive for the housing market. However - right now - these declines are probably misleading.