Definition: The shadow inventory counts the houses that are in some stage of foreclosure, but have not yet reached the market. CoreLogic defines it as the number of distressed properties not currently listed that are seriously delinquent (90 days or more), in foreclosure and owned by lenders. It does not include homes that are behind on payments, but the bank hasn't begun foreclosure procedures. The shadow inventory is somewhere in the foreclosure pipeline, and so must be added to unsold homes that are listed as for sale.

There are widely different estimates of how many homes are in the shadow inventory -- anywhere from 1.7-7 million. CoreLogic estimates there were 1.6 million homes, or nine months of supply, as of October 2011. This is down slightly from 2 million units a year earlier. This shadow inventory could keep housing prices flat for anywhere from one to three years. Investors are reluctant to buy homes now, knowing the shadow inventory is hanging out there. They will wait until these foreclosed homes are absorbed, and prices have a better chance of rising sooner.

The shadow inventory is in addition to the real inventory of unsold homes. This was around 4 million homes as of September 2011. At current rates of sales, this is an 8.5 month supply. Another 250,000 homes are added to the shadow inventory each month. Unfortunately, government programs haven't yet made a dent in the shadow inventory. A two year glut of unsold homes and shadow inventory probably means housing prices will stay flat unless the Federal government really focuses a whole lot more on this problem.

What Can Be Done to Reduce the Shadow Inventory?

Why has the government virtually ignored this looming threat? They may not know what to do. PIMCO fund manager Bill Gross suggested using government funds to turn all 5-7% mortgages into 4% mortgages. He said this would lift housing prices 5-10%.
So far, most initiatives haven't worked to fundamentally stem the foreclosure tidal wave. The HARP (Homeowner Affordable Refinance Program) was introduced in April 2009. It allowed the 2 million credit-worthy homeowners who were upside-down in their homes to refinance with today's lower mortgage rates. Unfortunately, only 810,00 homeowners have been helped. Why? Banks cherry-picked the best applicants.

The Treasury Department launched Making Homes Affordable in 2009. It works with banks to help homeowners modify their loans before they go into foreclosure. Unfortunately, banks only modify the payments, not the principal. Since so many homeowners owe twice as much on their mortgage as the home is worth, many who are struggling realize it's pointless to struggle to make payments with little hope of a decent return on their investment.

The Federal Reserve has a consumer help web site, and one to help community leaders assess and address problem areas. The Fed is also keeping interest rates low and continuing to buy toxic debt from banks. However, this also hasn't addressed the root of the foreclosure problem for homeowners.

Amazingly enough, some legislators have suggested things that will only worsen the problem. Some have suggested abolishing Fannie Mae and Freddie Mac. This would be a disaster, since their loan guarantees are required before a bank will even look at a loan. Before the financial crisis, they guaranteed 50% of all mortgages. Now, it's 90%. Second, the Dodd-Frank Reform Act required a 20% downpayment on all mortgages. This should not go into effect until housing is fully recovered. According to the National Association of Realtors, only 40% of recent homebuyers could even afford a 20% down payment.(Article updated December 27, 2011)

Shadow Inventory in the News

• September 2011 - Home Sales 7% Higher Than Last Year: Banks started working through the foreclosure pipeline, boosting home sales but lowering prices.
• July 2011 - One Million Foreclosures Pushed Out to 2012: Foreclosures continue to back up, thanks to delays in bank processing. It took 318 days for banks to foreclose in the second quarter, 41 days longer than a year ago.
• May 2011 - Home Prices Keep Falling: Sixteen million homeowners (28%) were upside-down in their mortgages, adding to the shadow inventory, and causing home prices to fall 1% a month.
• December 2010 - Foreclosure Probe Adding to Shadow Inventory: The foreclosure rate was down 24% from the prior year. This should have been great news, but wasn't. It was only because banks were slowing down their foreclosure process in response to a Federal government probe on their hurried foreclosure practices. Homeowners continued to fall behind on their payments. This just added to the 1.8 million homes in the shadow inventory.
• Economic Growth in Fourth Quarter 2010 was 3.6%: What held it back? A sluggish housing market. After most recessions, housing is usually the first sector of the economy to recover. New home construction is a great way to create jobs. Construction jobs have been sorely lacking in this recovery.
• September 2010 - Foreclosure 35% of All Sales: This is lower than a year ago, thanks to banks slowing down the foreclosure process in response to Federal investigations.
• July 2010 - There Are Two Homes in Foreclosure for Every One for Sale: A study by Capital Economics says there are 7.8 million homes in the shadow inventory. This is much worse than CoreLogic's estimate of less than 2 million homes.
• April 2010 - Option ARM Loans Worsen Shadow Inventory: These loans only made up 2% of all mortgages nation-wide, but 60% in California. They have penalties for refinancing, among other dangers.
• October 2009 - Shadow Inventory Looming: As early as October 2009, Barron's magazine warned about the shadow inventory, which would take 15 months to work through even back then.
• May 2011 - Home Prices Keep Falling: This week, Zillow's report showed house prices are down 8% from a year ago, and continue to fall about 1% every month. Sixteen million homeowners (28%) were upside-down in their mortgages, adding to the shadow inventory, and causing home prices to fall 1% a month.
• July 2011 - One Million Foreclosures Pushed Out to 2012: Foreclosures continue to back up, thanks to delays in bank processing. It took 318 days for banks to foreclose in the second quarter, 41 days longer than a year ago.