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What If Housing Takes a Double-Dip?

"We don't want to end up with any unintended consequences that prevent private capital from returning or further restrict sound lending and ultimately go counter to the reset we're trying to achieve," Bank of America (BAC - Get Report) CEO Brian Moynihan said of the mortgage rules in a speech at the Brookings Institution Friday.

Meanwhile, on the supply side, the tight inventory situation that has helped drive prices higher might not last.

In some states such as Florida, New York, New Jersey and Illinois, where a judicial foreclosure process requires banks to prove in court that the borrower is in default in order to foreclose, there is a large and growing backlog of foreclosed properties that are yet to come on to the market.

The share of mortgages in foreclosure in judicial states averages 6.6% compared to 2.4% in non-judicial states, according to the Mortgage Bankers Association.

According to former Morgan Stanley analyst Oliver Chang, who now runs Sylvan Road Capital , the "years supply" of foreclosed homes in New York is 40 years!

Shadow inventory, which refers to the amount of troubled loans still in the foreclosure pipeline that are yet to hit the market, has become less of a concern in the past year.

One major reason has been that the big banks- Bankof America (BAC - Get Report), JPMorgan Chase (JPM - Get Report), Citigroup (C - Get Report) and Wells Fargo (WFC - Get Report) have increasingly opted for short sales and other forms of mortgage relief such as loan modifications instead of foreclosures.

The shift has been good news for the housing market. One, short sales sell at a lower discount to the market than foreclosures, thus easing the pressure on home prices. Secondly, pursuing foreclosure alternatives first ensures that distressed inventory hits the market in a more measured pace rather than all at once.

Yet, no one can be sure that this shift away from foreclosures is permanent. Much of this change of heart has taken place in the wake of the foreclosure robo-signing scandal. First, there was a moratorium on all foreclosures. Now banks are rushing to comply with the terms of the $26 billion mortgage settlement signed earlier this year, which requires them to actively consider foreclosure alternatives.
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