The Emperor’s New Clothes

Everyone remembers this story, "The Emperor’s New Clothes", where an Emperor is sold a new outfit made of the finest “invisible” cloth.  Everyone in the parade is celebrating and can’t believe how incredible his new outfit looks...that is until a small boy in the crowd yells out “The Emperor is naked!”, and then everyone realizes he's just naked.

I bring this story up because as of late I feel just like this little boy, and the “Market Recovery” everyone is jumping up and down about is really just a naked Emperor.  Recently, it seems that everytime I turn on the radio or see an expert on TV  “RECOVERY” is all I hear.. I can’t help but ask myself who is right and what is actually happening.

So here is the Data:

Prices across the country are up +12% over the last 12 months.  Supply and demand drives the market, right?  Demand did not increase significantly so the driver in price increases must be related to inventory.  IS inventory down? Yes! Numbers show inventory is down more than 32% over the last 12 months!  Price increase is good but I have to ask why has Inventory decreased so much?  It means the funnel that fed inventory has been shut off rapidly, but how did that happen?

Point 1)  REOs and foreclosure filings have been a mainstay in the market the last 5 years, and if you are a REO agent you have seen your pipeline dry up overnight.  Why?  I researched this question and found the following: the REO inventory is not gone - it has just shifted.  Fannie and Freddie along with other large note owners started selling off large amounts of REO (on the market and shadow) to Wall Street Hedge funds mid 2012, and it will continue throughout 2013.  So the reason the REO inventory is down makes sense, as these houses have not reentered the market, yet.  Thus a factor as to why national inventory has decreased 32%.

Point 2)  What about the banks delinquent loan inventory and short sales?  The short sale data being reported you will see that less short sales are closing over the last quarter.  Are short sales going away?  Also If you are working in the short sale market you have seen a major shift in loan servicing over the last 6 months.  Bank of America, GMAC, Citi and Chase, loans (both firsts and seconds) being sold outright before and during the short sale process.  Large banks sold off defaulted and high risk notes in bulk to Wall Street funds in 2012 and it will only increase through 2013, as more banks don't want to deal with all of the federal regulations shoved down their throats.  Many national data providers are reporting shadow inventory is decreasing and defaulted notes are decreasing in the bank inventory.  Is the drop in delinquent shadow inventory a reflection of our economy getting better or is it a reflection of this sell off?  Which brings me to point #3.

Point 3)  Recent reports show foreclosure starts are down by 30%.  Are the fundamentals of our economy so good that 30% less people have more income and more jobs overnight?  What about the fact that unemployment is relatively unchanged, average household income continues to decrease, labor participation rates are decreasing and sequestration pay cuts are taking effect?  Are there fewer defaulted notes or are these statistics just a reflection of this sell off?  Banks won't spend money to start the foreclosure process if they know they are selling the notes.  Does this make sense yet? 

So Inventory is down and that is driving up prices.  Pre foreclosure sales are being pushed to the right and foreclosure starts are down due to a defaulted not sell off.  

All of this has quickly constricted the inventory pipeline that has fed the market since 2007, and this rapid decrease has resulted in a rapid supply and demand price increase.  This artificial appreciation has not happened through normal economic forces.  So what happens when the inventory build up catches back up with the market?

I spoke to a room full of Agents in Tucson about this last week, and I left them with this.  1) The market is appreciating, take advantage of it now.  2) Understand why and you’ll be in a position to prosper when natural forces of the economy adjust the market again.

So am I just a silly little boy in the crowd that needs glasses or is the Emperor really naked?  

-Karl