The cry of “wave!” continues. You don’t have to wait long between news stories about shadow inventories and impending waves of foreclosures that are poised to devastate the housing market.

In September, Bank of America predicted “a spike from now to the end of the year in foreclosures.” A spike that didn’t happen. Also in September, Amherst said that “favorable seasonals will disappear over the coming months, and the reality of a 7 million-unit housing overhang is likely to set in,” a prediction that was repeated last month in a hearing before the House Financial Services Committee.

Auctioneers on the courthouse steps called me before the end of the year to tell me to get ready for January as they had heard from their managers that properties will finally start selling, rather than continually postponing come January 1. Didn’t happen.

Even commenter’s on my  blog posts try to explain to me that there is a huge shadow inventory — as if I wasn’t aware that there a lot of property owners who are underwater, delinquent on their mortgage, or stuck in foreclosure limbo.

Like everyone else, I see the signs that a wave of foreclosures should have been upon us long before now. Yet for some time now I’ve been a fairly lone voice in saying that a foreclosure wave isn’t coming.

So why do I believe there will be no foreclosure wave, at least not in the near future?

Because we simply don’t have either the political will, or the financial capacity to foreclose on everyone who is currently delinquent, not to mention the millions more who will become delinquent if the housing market is crushed with a wave of new inventory.

Our financial institutions are still struggling to get their footing, the FDIC is in no position to bail them out, and taxpayers have had more than enough of bank bailouts.

And while little has been done by Congress to address the root problem of negative equity, they certainly have worked to prevent foreclosures and preserve home values.

So if not a wave of foreclosures, what do I think we can expect instead?

Foreclosure limbo consisting of continued government interventions, whether in the executive, legislative or judicial branch, at the state level, by the Fed or even supposedly independent oversight boards.

They’ll accomplish this by keeping a bid under housing prices through low interest rates and tax credits; forcing banks through hoops; threats; foreclosure moratoriums or any other means necessary. As such I see little chance that housing will be allowed to fall, no matter the cost.  Instead we will “extend and pretend” for years to come.

Foreclsoures will continue to be trickled out  at something near the current rate. They can’t stop foreclosures completely or everyone would simply stop paying their mortgage.

Some may argue this won’t work. Certainly homeowners can’t just stay in their homes free forever. Perhaps, but governments should also not be able to run deficits forever – yet for now at least, they do.

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Nick Timiraos over at the Wall Street Journal called my attention to a new study out from the New York Fed. It essentially says that loan modifications are less likely to default if they include a principal balance reduction. While my initial reaction was simply “Duh”, I’m glad to see this minor acknowledgement of the real issue – negative equity – at the federal level.

I’ve known for a long time that with the exception of the Five D’s (Death, Divorce, Drugs, Disease and Denial), foreclosure is the result of negative equity which leaves the homeowner trapped in a prison of debt unable to sell or refinance (with the possible exception of a short sale). Negative equity is so obviously the root cause of foreclosure it is hard for me to believe that the Fed had to commission a study to find out that loan mods which fail to address this core issue are less likely to succeed.

The root problem with the current Making Home Affordable loan modification programs, and the general idea that negative equity does not have to be addressed in order to avert this crisis can be traced back to a study by the Boston Fed. That study  essentially concluded that negative equity was not enough in and of itself to result in default and that job loss or some form of payment shock, like payment resets, was also required. They looked at Massachusetts foreclosures from the 1990’s to come to this conclusion. I instantly had issues with the study, given that the 90’s downturn was due to a recession rather than a massive bubble, because home prices dropped far less then vs. now, and a much smaller percentage of the population was affected. How anyone could think that period was indicative of what we could expect this time around was a clear example to me of how economists regularly get lost by failing to take into account basic common sense. You’d think they’d get that after nearly universally missing the housing and credit bubbles which got us here in the first place. I wasn’t the only one who thought this study was off base and I thought the folks over at the Kellogg School addressed its short comings nicely in their study on Strategic Default.

Now perhaps, with this latest study, the Fed is finally getting a clue and coming to the realization that addressing negative equity will ultimately be a required part of getting back to a healthy housing market. And if so, what’s next? Nick Timiraos noted today that Barney Frank doesn’t think we can force lenders to lower principal balances. But perhaps the quiet move on Christmas Eve by the Treasury to remove the cap on funding to Fannie Mae and Freddie Mac is an effort to get this done through the backdoor… at taxpayer expense.

No question in my mind that we have to address the negative equity problem. The only question now is how. Will the powers that be try to sneak it onto the back of taxpayers, will they force lenders to eat the losses potentially pushing our financial system back to the brink of collapse, will there be a national discussion and administrative leadership on how to best deal with the excess $4 Trillion in housing debt, or will they continue to extend and pretend with foreclosures trickling out for years to come? My money remains on the last choice, but I’ll be watching closely.

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Three interesting news items on the foreclosure front. First from the Atlanta Journal Constitution comes the story of a man robbing a bank to pay his mortgage. Apparently, the man handed the teller at SunTrust Bank a note that read “give me the money … I need to pay my mortgage … Merry Christmas.”

I was beginning to think we might see some better alternatives for homeowners terminally underwater than bank robbery after the Treasury Department provided details on their upcoming Home Affordable Foreclosure Alternatives program that made some progress on making short sales and deeds-in-lieu easier for homeowners who work with their lenders rather than simply “walking away”. Yet, just days later, HUD issued a letter to lenders classifying short sales by homeowners looking to escape their prison of debt as “strategic defaults,” and making those homeowners ineligible for future FHA financing with few exceptions. Examples of acceptable exceptions include “death of primary wage earner,” or “long-term uninsured illness,” with no mention of job loss.

Now contrast that with the following story from Bloomberg News – Morgan Stanley relinquished to the lender 5 commercial properties in San Francisco they bought at the top of the market in 2007. The current value of the property is estimated at $279 million, close to half of the value when Morgan Stanley bought it 2 years ago. Alyson Barnes of Morgan Stanley assured reporters, “This isn’t a default or foreclosure situation. It is a negotiated transfer to our lenders.”

Let’s compare and contrast. When things got tough for financial institution Morgan Stanley, they got $10B in TARP money, they walked away from their mortgage as part of a “negotiated transfer”, and got to keep their investment grade A+ credit rating. Joe Homeowner, on the other hand, is left to choose from continuing to throw good money after bad (payment based loan modifications), ruining their credit and chance to buy another home (short sale, deed-in-lieu or foreclosure), or apparently, robbing a bank.

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Why the army of 1.2 million Realtors should be deployed to fight the war against negative equity.

By any measure, the administration’s attempts to resolve the housing crisis have been, and continue to be, dreadfully ineffective. And they’ll continue to fail while they offer solutions that are worse than the policies that created the crisis in the first place.

Instead, let’s find real solutions and engage an army of Realtors, 1.2 million strong, to address the real problem.

The problem isn’t a big mortgage payment or a temporary drop in home value. The problem is $4 trillion in negative equity that was created by an epic credit bubble.

The best Washington can come up with is to incentivize mortgage servicers and lenders to push payment-focused loan modifications, which only leave homeowners upside down in a prison of debt, albeit with affordable payments. If we ever want to return to a healthy housing market, or a strong consumer base in our consumer driven economy, we’ll have to address the reality that millions of U.S. households are terminally upside down. And, as the administration has already realized, that can only be accomplished the way Realtors do things, one household at a time.

Realtors are on the front lines in this struggle. Like homeowners, their personal wealth has been adversely affected by the dramatic change in the housing market. Some may say Realtors took advantage of the housing bubble and helped create the crisis. However, in reality, they simply and dutifully followed our leaders in Washington, and the powerful financial institutions on Wall Street who rewrote the rules of the game.

Yes, these rules were often supported by the Realtor’s own industry leaders, who pushed for new loan programs, home-buyer tax credits and unsustainably low interest rates. Those same leaders encouraged them to ignore negative signs in the market and ceaselessly insisted that “now is a great time to buy;” even writing and promoting books on why the bubble would never burst.

We shouldn’t blame the foot soldiers for the mistakes of their generals.

It is in every Realtor’s best interest to see this nation get back to a healthy housing market. One where 25 percent of homeowners aren’t upside down in their mortgage, one where homeowners make their mortgage payments, and one where foreclosure isn’t a daily headline.

What we need are for our generals in Washington to develop policies that make sense, translate them into coherent marching orders, and unleash a troop surge of ready, willing, and able-bodied Realtors that can and will make real gains in the struggle against negative equity and return us to a healthy housing market, one household at a time.

The reality is that there is no one solution to this problem. Some owners are in homes they will never be able to afford; some are suffering temporary job loss; while others have already abandoned their home and moved on. Mortgage servicers are not equipped to address the problem. They lack the manpower to answer their phones, let alone talk with each owner, visit their home, and walk them through their options. Realtor’s have the manpower, and are eagerly awaiting clear instructions on how to best help homeowners and make a difference in their community. The truth is that their livelihoods depend on it.

Our army of Realtors should be mobilized now, as they can be the front-line resource for homeowners looking for a rational way to win their personal housing battle that will, in turn, lead to our winning the war against negative equity, returning us to a healthy housing market, and perhaps even a strong national economy.

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Monday, the administration announced a nationwide campaign to push their failing Home Affordable Modification Program (HAMP) out of the HAMPer. Until now the focus has been on getting loan modifications started with a stated goal of reaching 500,000 trial modifications by November 1, 2009. Unfortunately, despite having successfully hit this goal, it is becoming increasingly clear that the program is failing, as few of these trial modifications have converted to permanent modifications. A little over half of the 650,000 borrowers who started trial loan modifications are eligible to convert to permanent modifications by the end of 2009. The administration’s announcement today is an effort to rescue the program and make sure these modifications actually do convert with a campaign to:

• Extend the trial period, to allow more borrowers to complete the paperwork.
• Develop publicly reported operational metrics, to hold servicers accountable for their performance.
• Possibly impose monetary penalties and sanctions on under-performing servicers.
• Engage HUD field-office staff and HUD-approved counseling organizations to distribute outreach tools.
• Engage the National Governors Association (NGA), National League of Cities (NLC) and National Association of Counties (NACo) in thousands of state, local, and county offices, to increase awareness of the program and assistance for borrowers.

Apparently the assumption is that borrowers aren’t completing the paperwork because it’s too complex or confusing. But what if they aren’t completing the paperwork because they’re reluctant to fall for another toxic mortgage?

High-risk, sub-prime option ARM loans contributed to this mess in the first place. To fix the problem the administration proposes to:

• Offer homeowners temporarily lower payments on loans they are unlikely to ever be able to repay.
• Force servicers to expedite applications under threat of public flogging, financial penalties and sanctions.
• Enlist private associations and government agencies at all levels to hawk the its program as being good for homeowners.

Maybe borrowers have figured out that this program is really only another exotic mortgage like one they fell prey to when they bought or refinanced the house that resulted in their current predicament. HAMP and the adminstration’s newly announced campaign isn’t digging borrowers out of a hole. It’s only digging them a new one, and delaying the inevitable.

The original hole was created with a clear downside and a theoretical upside:

• The downside: exotic financing, that qualified buyers for homes they clearly couldn’t afford by offering a low payment up front, despite unaffordably high payments in the future.
• The upside: the expectation that the appreciated value in the house will allow the borrower to refinance or sell at a profit before their payment skyrockets.

The new hole offered by HAMP is all the downside with none of the upside.

• The downside: exotic re-financing, by which they make payments affordable today, but leave homeowners in the same boat down the road when payments ratchet back up after 5 years.
• The bonus downside: there is no reasonable expectation that home values will appreciate anywhere near enough to get these loans above water before the 5 years is up, or before the homeowner runs into a real life event like job loss, divorce or job relocation – leaving them stuck in an upside down prison of debt.

What’s more, it’s not just bad for borrowers, it’s bad for everybody. Servicers and lenders simply delay their inevitable losses and suffer a lousy rate of return thanks to the artificially low payment until then. Everybody suffers as the economy limps along, as it is hard to justify a spending spree when you are upside down in your home by tens or even hundreds of thousands of dollars. Even the stealth stimulus package disappears as people make their modified mortgage payments.

The housing problem may need an intervention, but not this intervention. Like offering drugs to an addict, repeating our past mistakes by putting people back into exotic mortgages is certainly not the cure. It’s time to go through withdrawal and kick the habit by addressing the real problem, negative equity.

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Fannie Mae slipped out a press release just before the Thanksgiving Holiday announcing their new “First Look” Initiative. Under the guise of neighborhood stabilization the program gives home buyers (those who plan to live in the home themselves) and public entities the first shot at buying any Fannie Mae REO’s — investors are locked out unless Fannie does not receive an acceptable offer within the first 15 days.

On first blush, this seems positive. Afterall, owner occupied homes should in theory be better taken care of which is good for neighborhoods, and public entities are using our money to buy so why make them compete with investors.

Let’s not forget though that Fannie loans are backed with “our” money as the loans from these entities have an implicit, if not explicit, guarantee from the federal government (this point could have been argued until we took them under conservatorship in 2008 – now I think their losses are unquestionably our losses). As such, I’d think our goal should be to limit Fannie’s losses, not limit competition to help certain buyers over others.

There’s no question this program could provide some relief to folks trying to buy a home to live in. We regularly hear about home buyers losing offer after offer to all-cash investors willing to pay prices not only over asking, but above appraisal value. An incredible fact given that we have a record number of homeowners facing foreclosure, and had exploding supply a year earlier. Just keep in mind that we only have this feverish battle right now because the government has worked hard to artificially limit supply, and artificially pump demand. So I have a simple question: is the problem that the real estate market is so slow that we need to stimulate it with low interest rates and tax credits, or is the market so hot that we need to protect home buyers from competition?

What I find even harder to understand is why this “First Look” program extends to public entities. As you may recall the government launched a number of programs to buy up foreclosures in an effort to limit their impact on neighborhoods. The theory at the time was that there would be far more foreclosures then there would be traditional buyers (homeowners and investors), and that these programs would help clean up the extra supply. But that is not the way it played out.

Instead we now have these programs competing for homes at a time when there simply is not enough supply for current demand (not unusual to see 10+ offers on a clean REO in California right now). As such it makes no sense for these public entities to use taxpayer funding to buy foreclosures AT ALL right now, let alone have Fannie  limit competition and take a bigger loss (using taxpayer dollars) to allow these public entities to buy them cheaper.

Bigger picture this program probably doesn’t matter much. There are so few REO’s coming to market right now, investors are already giving up on them and moving on to buy at trustee sales (foreclosure auctions). While riskier for inexperienced investors, the trustee sales are true public auctions where anyone with a check can come and compete for these homes before Fannie gets a chance to decide who does, or does not, get the “First Look”.

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A record-high 23,117 trustee sales are scheduled for sale Monday, November 30^th,  in the ForeclosureRadar.com coverage area (CA, AZ, NV, WA, OR).

Because state laws do not allow trustee sales on state holidays, we expected to see a significant bump in sales Monday. However, the total number of trustee sales per day for the region is typically five to six thousand. To cover Thursday, Friday and Monday, the number of sales should reflect three days (15,000 – 18,000). In addition, trustee sales typically slow during the holidays and see a bump in January.

So it’s a little surprising to see four-day’s worth of sales from a three-day period right after Thanksgiving. That being said, it doesn’t mean 23,117 families will lose their homes on Monday. Lately, ninety percent of trustee sales are just postponed to another day.

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In Part 1 of the nine-part series on the credit/housing bubble, I mentioned what I considered the three most notable contributors to the housing bubble: the Financial Services Modernization Act (1999), the Commodity Futures Modernization Act (2000), and artificially low interest rates after the dot-com bubble popped (2001).

While Congress continues to debate how to best re-regulate financial institutions to avoid repeating our past mistakes, I believe they have unwittingly set us up for a coming mini-bubble in early 2010.

It started with their well-intended efforts to stop foreclosures, ostensibly to keep prices from falling further. Through such programs as the Home Affordable Modification Program, relaxation of mark-to-market accounting rules, changes to foreclosure rules, and even overt threats they have significantly slowed foreclosures, and dramatically restricted the supply of homes for sale.

At the same time, by renewing the first-time homeowner tax credit and encouraging the Fed to keep interest rates artificially low by backing mortgages with taxpayer funds, the government has increased the demand for homes.

The goal of these measures is ostensibly to aid the housing market (read “keep prices from falling further”) by attracting buyers, while simultaneously preventing the purported wave of foreclosures from crashing on the housing market. For what it’s worth, attempts to constrain supply and stimulate demand are working. These days it’s not unusual to see ten offers on a house in California, as unbelievable as that may seem.

And so comes the mini-bubble. Stimulated demand with limited supply will have the inevitable effect of artificially inflating prices. Again.

To be clear I don’t expect this to be a significant bubble. Lending and appraisals remain far too constrained to let what happened earlier this decade repeat itself. Prices aren’t about to magically double. And that is kind of my point. There is ZERO chance we are going to get back to the price levels reached in 2005. We simply don’t have the incomes in California to support those prices without 1% negative amortization teaser rates – which I for one hope are not coming back.

Even if we could artificially stimulate our way back to 2005 price levels, would it really be a solution? Should it even be the goal?

Maybe it is time we realize that it is far healthier to have prices at levels that people can actually afford, given loan terms and interest rates that are sustainable for the homeowner and attractive to an investor other than the Fed. Anything else is simply setting us up for future failure. How can anyone think that prices won’t fall if the Fed someday stops artificially lowering interest rates, or Congress stops stimulating demand?

This boom-bust yo-yo effect is the unhealthy result of stopgap solutions that deal with the symptoms, rather than substantive solutions that address the root problem – unsustainable negative equity. Until everyone realizes that we can’t eliminate that negative equity through artificially higher prices, don’t expect a truly stable housing market. Instead, buckle up and prepare for the ride – with more ups and downs to come.

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I’ve talked in the past about some of the approaches to rescuing the housing market and providing economic stimulus, such as the Treasury Department lowering mortgage interest rates, the California Foreclosure Prevention Act, the Countrywide settlement, and the Housing and Economic Recovery Act of 2008.

Despite all of these measures we remain in housing limbo, with millions of homeowners underwater on their mortgages and unable, or unwilling to make their payments; yet with few being foreclosed, as lenders and the government desperately search for alternatives.  The reality is that we will likely remain in limbo until we as a society develop the political will to either move ahead on foreclosures, or bail out homeowners.

However, one effect of this housing limbo is the free rent we’re effectively giving to those homeowners, and the contribution this free rent provides to the local economy.

When homeowners quit paying $1500 per month on their mortgage, that cash is available for other parts of the family budget. I’ve purchased 150+ foreclosures, and I can’t remember a single homeowner that wasn’t broke when it came time to move. Rather than saving, they’re going out to dinner, subscribing to sports packages on TV, and buying iPhones or netbooks. Many of those purchases would have to be delayed, or foregone altogether, if they were still paying their mortgage.

By allowing banks to stall on foreclosures and keep non-paying assets on their books, we’ve enabled a redirection of resources that provides a short-term boost to the local economy, a stealth stimulus package. Whereas paying that money to the lender through mortgage payments would probably take it out of state, and maybe even overseas to China; shopping locally with that same money keeps it working in the local economy, and benefiting local businesses.

In addition, local governments are benefiting from increased sales tax revenues. Some may say that this gain is offset by the loss of property taxes, since people who don’t pay their mortgage also quit paying their property taxes. But property taxes will eventually be paid, with accrued interest on the next title transfer. Thus there is no loss of property tax revenue but rather a simple delay in payment.

With rising unemployment, this (perhaps unintended) stealth stimulus couldn’t come at a better time for local economies. When I go out to dinner I look around and wonder—how many folks around me are out tonight thanks to a delayed foreclosure, and no mortgage payments.

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There is currently no shadow inventory of bank-owned (REO) properties. What’s more, a surge in REO properties is not likely anytime soon.

If this sounds familiar, it’s because I’ve said it before, here and here and other places. However, it still seems to be news (see the recent WSJ article) and despite the fact that the most recent CA Foreclosure Report from ForeclosureRadar.com runs the numbers, some still insist the shadow is there.

First, let’s be clear about what shadow inventory is. These are homes that the bank has already foreclosed on, but which, for no apparent reason, aren’t listed. The implication is that banks are holding REO properties back from the market to restrict supply and prop up prices. This actually seemed like a distinct possibility a year ago when the banks were clearly holding more inventory than they were listing. But that is no longer the case. In the past year, they have resold far more than they’ve taken back, eliminating any possibility that a shadow remains.

Some observers, who earlier this year warned that this shadow inventory would deluge the market with REO listings, have now redefined shadow inventory to include properties that should be foreclosed on. They continue with misguided warnings of a deluge of REO listings any moment now.

Not so. These properties are not lurking in the shadows at all. We know exactly which properties are in trouble and where they are in the process. Using ForeclosureRadar.com you can easily see every potential REO listing, from Notice of Default to Notice of Trustee Sale, for the next six to nine months. In addition, even if banks reversed course and started foreclosing aggressively today, it would be months before we saw those listings as it takes time to evict the homeowner, clean up and list the property.

What’s more, they’re not going anywhere. These properties aren’t grinding through the pipeline to foreclosure and into the shadow inventory. They’re not moving at all because we as a society lack the political will to foreclose. Because the national focus is targeted on keeping homeowners in their homes, the drain is bigger than the spigot – REO properties are selling faster than distressed properties are being foreclosed on.

As a result, the pendulum has swung to the other side. Instead of a glut of properties hitting the market, as so many have warned, we currently don’t have enough inventory for those who want to buy homes, and homeowners are still in trouble because the so-called solutions (foreclosure moratoriums, loan modification, refinancing) don’t fix the real problem, which is negative equity.

No more conspiracy theories. We need to abandon the obsession with shadow inventory, which distracts us from the national discussion we should be having. With the current lack of inventory, its time to force banks to clean up their balance sheets by dealing head-on with the trillions in negative equity that remains, either though loan modifications that reduce principal balances to near current value, short sale, or, if necessary foreclosure. These are the only solutions that deal with the core problem of negative equity. It’s time for “extend and pretend” to end.

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