Analysts have shown a propensity to announce that the country has hit a bottom on housing, throwing a host of facts and figures together to prove it. Many of these analysts benefit financially from the appearance of a housing recovery, and certainly banks benefit greatly as well. Earnings reports from JPMorgan Chase and Wells Fargo have highlighted the improving housing market, and this has boosted their stock price.

And there are growing indications that this is all based on a convenient fiction around artificially reduced supply. A little-noticed item at AOL Real Estate, based on the same industry data banks and analysts use to tout a recovery, introduce us to the scam in “shadow REO”:

This home is part of what’s known as the “shadow REO” (REO stands for Real Estate Owned) inventory: repossessed homes across the country that banks or investors often purposely keep off the market. The practice isn’t a secret, and refraining from dumping a large inventory of foreclosures on the market helps to keep home prices from crashing.

But the extent to which lenders keep their stock of REOs — industry parlance for “real estate owned” properties — off the market may be much larger than most people think.

As many as 90 percent of REOs are withheld from sale, according to estimates recently provided to AOL Real Estate by two analytics firms. It’s a testament to lenders’ fears that flooding the market with foreclosed homes could wreak havoc on their balance sheets and present a danger to the housing market as a whole.

Online foreclosure marketplace RealtyTrac recently found that just 15 percent of REOs in the Washington, D.C., area were for sale, a statistic that is representative of nationwide numbers, the company said.

A Liability to Lenders

Analytics firm CoreLogic provided an even lower estimate, suggesting that just 10 percent of all REOs in the country are listed by their owners, which include mortgage giants Fannie Mae and Freddie Mac as well as the Federal Housing Administration. As of April 2012, 390,000 repossessed homes sat in limbo, while about 39,000 were actually listed for sale, said Sam Khater, senior economist at CoreLogic.

One of the main reasons for the alleged recovery in housing prices comes from this constraint on supply. With fewer and fewer homes on the market, the bidding for what’s left available goes higher. Prices rise and distressed sales fall (because the distressed sales are kept off the market). There are other factors, but shadow REO of up to 85-90% is a huge one that doesn’t play into most analyses.

There are all kinds of reasons for this. Lenders have to book a loss when they sell a property, and can keep the loss off their books until that time. So this is a classic extend and pretend move. But there’s more. While these homes may be in disrepair (roof damage, mold, plumbing, etc.) when vacated and need to get brought back into a salable form, the bigger issue is that properties still technically in foreclosure are subject to something called “property preservation.” The servicer does inspections of the property and collects fees. And there are indications that they are making thousands of dollars per property, in some cases thousands a MONTH, by abusing property preservation fees. The investors are getting fleeced by this penny-ante scheme. It’s not on the level of foreclosure fraud as a whole, but it shows another way the servicers benefit from foreclosure, by larding on fees after the eviction but before the sale.

But I see the major issue as Yves Smith does, with the creation of artificially “tight” inventories boosting the housing market.

But we’ve seen so much evidence that the inventories that the commentators are looking at are misleading it isn’t funny. Banks were attenuating foreclosures even before the robosigning scandal broke. In the states with real housing distress, banks will take foreclosures up to the stage of actually taking title from the owner, and let it sit in limbo for a protracted period. But in addition to delays in real estate being taken into REO, there is also evidence of banks simply not putting real estate owned by securitizations, the GSEs, or the banks themselves, on the market, thus keeping it out of visible inventories. For instance, numerous NC readers report they see vacant homes, want to make an offer, and can’t find out who to contact to do so. That is a pretty strong sign that those homes are also not in official REO inventories [...]

Of course, the discussion focuses on how much price manipulation is justified, as opposed to the real problem: we have had, and continue to have, far too many foreclosures and far too few mortgage modifications. But the solution seems to be to zombify the housing market rather than make servicers change their ways.

This has to be included in the great housing market recovery or not debate. We appear to have banks keeping inventory off the market deliberately to gouge prices upward and give the impression of recovery. And so far it’s actually working.