The two largest holders of real estate owned property (REO) in the country, the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), are biting their nails as their REO inventory grows while the real estate market shows all the signs of softening. After amassing over 191,000 REOs nationally in the first quarter of this year (more than double last year’s reclaimed REOs combined), Fannie and Freddie are buckling under their bloated inventories and threatening to crack-down on lollygagging lenders and servicers.

Fannie and Freddie’s newly initiated foreclosures have risen steadily over the second quarter of 2010 to more than 150,000 nationally in July, a 60% increase from April. In addition to a climbing national foreclosure rate, an estimated four million delinquent loans are sitting in limbo as shadow inventory yet to be foreclosed, many of which will eventually be absorbed into Fannie and Freddie’s REO inventory. [For more information on the shadow inventory, see the March 2010 first tuesday article, Where have all the REOs gone?]

These staggering numbers of REOs sitting in Fannie and Freddie’s storeroom have absorbed extraordinary amounts of maintenance expenses. Of the $13 billion worth of REOs added to the national inventory in the second quarter of this year, Fannie and Freddie have paid-out an estimated $487 million to cover utility bills, pay property taxes and hire real estate agents and contractors to rehabilitate the homes to maintaining property values. [For more information on Fannie and Freddie’s troubled balance sheets, see the August 2010 first tuesday article, Freddie and Fannie need more help, before disappearing.]

Surprisingly, Fannie and Freddie are in no hurry to sell the spate of homes they are sitting on. Since they either own or have guaranteed the majority of the market’s REO inventory, Fannie and Freddie have to be careful of their influence over home prices. If Fannie and Freddie cut home prices for marketing their REOs to compete with REO-holding, private-label mortgage backed bonds  (MBBs) or release too many of the REO properties all at once, they could adversely influence current market values across the board. This could potentially contribute to a double-dip downturn in the real estate market, which already appears to be underway.

One way for Fannie and Freddie to continue to hold on to their assets without continuing to hemorrhage money is through a lease-and-hold approach. By renting foreclosed properties while the market finds its equilibrium, Fannie and Freddie can keep houses out of the REO rental market and, at the same time, cover some of the maintenance costs on the rent they receive from foreclosed properties. Thus, this would save millions of dollars that can be used to fund new programs to further promote the stabilization of the real estate market.

As they continue to grow weary under the weight of their REO inventory, and as they are poised to accumulate even more foreclosures in the coming years, Fannie and Freddie are becoming increasingly impatient with lenders who take too long to reclaim vacant homes. Thus far, only idle threats to charge fines to procrastinating lenders have been made, but Fannie and Freddie’s frustration is palpable.

first tuesday take: Funding maintenance costs for vacant REOs is the least of Fannie and Freddie’s worries – a pittance in the grand scheme of resolving their insolvency. What is $500 million of maintenance costs compared to the inevitable landslide of shadow inventory foreclosures set to be incorporated into Fannie and Freddie’s already distended REO inventory?

Renting out a few foreclosures may mitigate some of Fannie and Freddie’s current fiscal injuries, but their losses will only be compounded exponentially since these lenders must eventually sell their REO inventories and report their losses. Non-government lenders delay reporting their losses to protect their fragile balance sheets by taking advantage of the Federal government’s extend-and-pretend mortgage modification programs, such as the Home Affordable Modification Program (HAMP). [For more information on the floundering HAMP program, see the July 2010 first tuesday article, HAMP is losing participants.]

Given that Fannie Mae and Freddie Mac are under government conservatorship (read: full ownership), the federal government should be developing programs that impose strict regulations in order to put an end to the interminable delays perpetrated by lenders in clearing out delinquencies — the same parties that ultimately caused the real estate fall-out through their intense desire for a lack of regulation.

The results of forcing lenders who whine about everything, as do spoiled, untrained brats, to report their losses in a timely manner may initially be uncomfortable for everyone to hear, but at least getting their accounting right will paint an accurate picture of where the economy, and thus where the real estate market, is really going. Maybe then the organic recovery can finally begin.

Re: Reluctant Realtors: Fannie, Freddie” from the Wall Street Journal