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Why are housing prices falling when the number of houses on the market continues to decline? Usually, when supply shrinks, then prices rise, right? So, why isn’t that happening now?

The reason is that housing market never completely cleared, which is to say that the Fed’s interventions and the manipulation of inventory by the banks prevented the market from finding a bottom. So, now– a full 6 years after the peak in home sales in 2006–the real estate depression continues while prices drift lower still. And–here’s the bad part–no one knows how much farther prices will drop, because the existing inventory of homes on the market (according to the Wall Street Journal) is presently 1.89 million while the shadow inventory (according to CoreLogic)… is “1.6 million units” which represents another 5 months supply, “the same level as reported in July 2011.”

So we’re back to Square 1.

Here’s more from Corelogic:

“Currently, the flow of new seriously delinquent loans into the shadow inventory has been offset by the roughly equal flow of distressed (short and real estate owned) sales. CoreLogic estimates the current stock of properties in the shadow inventory, also known as pending supply, by calculating the number of distressed properties not currently listed on multiple listing services (MLSs) that are seriously delinquent (90 days or more), in foreclosure and real estate owned (REO) by lenders.” (Calculated Risk)

So, there’s a mountain of backlog to work-off before the market touches bottom and prices stabilize. But even that doesn’t accurately describe the troubles facing the market. The biggest obstacle to any real recovery is the millions of distressed homes that are set to come onto the market in the next few years. Those numbers will swell by many orders of magnitude when the banks and the 50 Attornies General agree to a settlement on the Robosigning fiasco some time in early 2012. When an agreement is finally reached, a flood of foreclosures will pour onto the market pushing down prices, wiping out precious homeowner equity, further eroding bank balance sheets, and forcing more underwater mortgage holders to “walk away”. Here’s how CNBC’s Diane Olick sums it up:

“The biggest headwind facing the recovery unquestionably is the distress leftover from the housing crash– foreclosures and properties with delinquent loans. ….Right now, there are approximately 6.2 million properties that have delinquent mortgages or are already in foreclosure….. Now not all of the delinquent loans will go to foreclosure especially if legal settlements involve principle write down and more loan modifications…. There is however a worst case scenario …from Amherst Securities which looks at loans that have been modified but likely to default. Amherst claims there are around 10 million loans in trouble. … 4 million 60 days past due. 2.5 million modified claimed will default. and 3.6 million under water loans that they say will likely go bad. Add all that to the current inventory of bank-owned homes, Fanny, Freddie, FHA, the banks, private label, and you get close to 3.4 million properties.” (CNBC, Diana Olick—Watch the whole video at CNBC http://video.cnbc.com/gallery/?video=3000068580.)

Did you catch that last part? The banks are going to have to get rid of another 3.4 million distressed homes even though the market is already completely saturated. That means prices have only one way to go…DOWN.

Remember, the banks find themselves in this pickle after having already been bailed out 3 times to the tune of many trillions of dollars. (The $700 billion TARP, the $1.25 trillion QE1, and the Fed’s lending facilities which provided blanket support to a cross-section of financial institutions for an estimated $12.4 trillion in loans and other commitments) And now, there’s going to be a 4th trillion dollar bailout, which many expect President Obama to announce on Tuesday in the State of the Union Speech. Here’s a little warm up for that event which appeared in the New York Times:

“President Obama will use his election-year State of the Union address on Tuesday to define an activist role for government in promoting a prosperous and equitable society, hoping to draw a stark contrast between the parties in a time of deep economic uncertainty.. …. Advisers and other people familiar with the speech say Mr. Obama will expand again on the administration’s effort to resolve the housing crisis with both carrots and sticks to lenders dealing with homeowners behind on their mortgage payments — (Obama’s) economic team holds that until the housing market recovers, the broader economy cannot — and that all Americans suffer…… Mr. Obama said he would call for “a return to American values of fairness for all and responsibility from all….”(“Obama to Draw an Economic Line in State of Union”, New York Times)

Okay, so Obama is going to wrap this new Banker giveaway in all kinds of populist gobbledygook. No surprise there! Still, it makes you wonder what the administration has up its sleeve? After all, “disappearing” a couple million homes is no easy task even when one’s economics team is chock-full of Wall Street insiders and banker wannabees. So, what’s the plan?

First of all, we need to recognise that–in order for Obama’s bailout to succeed–he needs to do two things at the same time. One, he must prevent the prices of financial assets (mainly mortgage-backed securities) from falling too sharply or the banks will suffer heavy losses. Second, he has to find a way to dispose of the millions of unwanted homes that will wreak havoc on prices if they are allowed to come onto the market.

As we all know by now, the way to keep “risk assets” bubbly is by firing up the printing presses and launching another round of quantitative easing (QE3) So, that’s probably a done-deal. Here’s what CNBC had to say on the topic in an article that appeared on their site just last week:

“The Federal Reserve is likely to step in with $1 trillion worth of easing that could be announced as soon as this month, according to a growing consensus of economists who see the recent uptick in economic growth as unsustainable. With the Fed’s Open Market Committee set to meet next week, expectations are rising that the languishing housing market will drive the central bank to buy up mortgage-backed securities. The goal of the purchases will be to drive down interest rates even further from current record-low levels, and, less obviously, to spur confidence that more monetary tools remain to stimulate the economy…. The $1 trillion price tag — Citigroup economists a few weeks ago also envisioned QE3 at that level — is significant in that it will send the Fed’s balance sheet to about $3.9 trillion and likely spark a war with Congress over the threat of inflation.” (“Fed’s Latest Easing Could Cost $1 Trillion: Economists”, CNBC

Of course, the Fed’s (proposed) purchases have nothing to do with “driving down interest rates” (which are already at historic lows) or “stimulating the economy”. That’s just more public relations hype. It’s all about inflating the prices of droopy financial assets that are eating up banks’ balance sheets. That said, Obama will still have to concoct a scheme for gobbling up all those foreclosures that are piling up on the banks’ books. How’s he going to do that?

So far, Obama hasn’t tipped his hand about the shape of the deal to come, but there are signs that the deep-pocket guys are already lining up at the trough. For example, get a load of this on Thursday’s Marketwatch:

“AG Mortgage Investment Trust, Inc…..(the “Company”) announced today that it has priced an underwritten public offering of 5,000,000 shares of common stock at a public offering price of $19.00 per share. The Company has granted the underwriters a 30-day option to purchase up to 750,000 additional shares of common stock at the public offering price to cover overallotments. The offering is expected to close on January 24, 2012 and is subject to customary closing conditions. The Company intends to use the net proceeds of the offering to make, as market conditions warrant, additional acquisitions of agency securities, non-agency residential mortgage-backed securities and other target assets, and for general corporate purposes. Deutsche Bank Securities Inc., BofA Merrill Lynch and Stifel Nicolaus Weisel are acting as joint book-running managers for the offering.” (“AG Mortgage Investment Trust, Inc. Announces Pricing of Public Offering of Common Stock”, Marketwatch

So, all of a sudden there’s a gold rush on “agency securities (and) non-agency residential mortgage-backed securities”? Well, fancy that. And it segues nicely with Obama’s (presumed) bailout plan, doesn’t it? Of course, it could all just be a coincidence, but how likely is that? After all, as we pointed out in an earlier article there are some pretty wealthy and well-connected people who are betting the farm that another round of QE will put MBS into the stratosphere. Here’s an excerpt from a post at Zero Hedge:

”….in December the fund (Total Return Fund or TRF) doubled down on its QE3 all in bet, by “borrowing” even more cash, or a record $78 billion, using the proceeds to buy even more MBS, as well as Treasurys, which hit a combined 31% of the TRF’s holdings. In other words, between MBS and USTs, Pimco holds a whopping 79% of total, mostly in very long duration exposure. In fact, this combination of long duration and pre-QE exposure has not been seen at PIMCO since late 2008, early 2009, meaning that as many banks have been suggesting, (Bill) Gross is convinced that the Fed will announce if not outright QE3 this January, then at least intimate it is coming.”(“Pimco Doubles Down On All In Bet Fed Will Monetize MBS”, Zero Hedge)

So what do these guys know that we don’t know?

But, then, QE3 is just part of the story. The other part is the presumed “Public-Private Investment Partnership” that will incentivize the big banks and private equity firms to buy up loads of distressed homes so they can convert them into rental units. “Why would they do that”, you ask? Because Team Obama is going to make them an offer they can’t refuse. All we need to do is to look back at the way Treasury’s Timothy Geithner cobbled together the first PPIP, and we can figure that it will be some variation of that same concept.

Here’s what you need to know about the first PPIP: Uncle Sam was supposed to stump up 94 percent of the financing (low interest, of course) for mortgage-backed securities (MBS) that no one else wanted. (This time it will be the houses themselves) The so-called “private partners” in this confidence scam, (Banks, private equity, hedge funds) would get non-recourse loans which they could get out of at any time if they felt their investment was at risk. Here’s how Paul Krugman summed it up at the time:

“The Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down, the investors can walk away from their debt. This isn’t really about letting markets work. It’s just an indirect, disguised way to subsidize purchases of bad assets.”

Bingo. It’s just more corporate welfare dolled up as as way to “stabilize the housing market”.

Also, the so-called partnerships were to be conducted via off-balance sheets operations, (Enron-type structured investment vehicles or SIVs), creating another layer of opaque accounting that would allow for additional (but predictable) mischief, malfeasance, fraud, you-name-it. It’s all part and parcel of Geithner’s sordid concoction designed to take John Q. Public to the cleaners one more time.

I expect that there will be a new public-private partnership that will feature many of the same perks as the first. The government will provide unlimited, cheap funding and will back those loans with the “full faith and credit” of the UST. Meanwhile, the banks and hedgies put up mere pennies on the dollar. In return, the taxpayer will get assurances that any profit derived from the renting of said units will be shared equally among the investors. In other words, the banker who put in $.06 while taxpayers put in $.94 will still rake in 50 percent of the profits.

Nice, eh?

The bottom line: The bankers need to trim their inventory and pump a little more ether into their sagging MBS. Obama and Bernanke will do whatever it takes to get the job done.

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion, forthcoming from AK Press. He can be reached at fergiewhitney@msn.com