Last week, I wrote about REO volumes and showed how bank-owned real estate was back on the upswing after two quarters of limited inventory—and by the end of last week, so too had most of the financial press. Which is flattering. This week, I’m going to build from last week’s column to take a more in-depth look at delinquency trending to help you get a feel for where the real estate market is headed next. (I can only hope the message is as widely followed by my journalistic colleagues this week, as well.) Last week, using data from Lender Processing Services [stock LPS][/stock], I highlighted the fact that there are some 7.5 million loans in some stage of delinquency, and noted that problem residential mortgage loans are growing—not shrinking. Take a peek at the below chart, which clearly shows that delinquency and foreclosure inventory is currently double the levels seen in the 1995-2005 decade. While the pace of delinquencies seems to be slowing somewhat as of late—good news, indeed!—we still face a situation where loans are going bad faster than we can offer a “fix.” Consider that 2.5 million loans, current at the start of 2009, had become 60+ days delinquent or in foreclosure by the end of January 2010, according to LPS. Compare that to the roughly 2 million loan modifications in process or processed in generally the same time frame—116,000 permanent HAMP mods + 830,000 trial HAMP mods + 1.0 million completed non-HAMP mods. It’s simple math: 2.5 million is greater than 2.0 million. And keep in mind that many of the loans modified now will inevitably re-default later, as most modifications bring with them substantial re-default rates—roughly 60% or so, according to most of the data I’ve seen (the Treasury does not report on HAMP re-default rates, by the way). JP Morgan Chase & Co. [stock JPM][/stock], for example, recently suggested to investors that it expects re-default rates on completed modifications to run 35 to 50 percent one year out, reaching as high as 65 percent 3 years out. So let’s assume the redefault rate over time is untenably optimistic and stays at 35 percent (JPM’s lowest bound, just for the first year). Even in such a scenario, we’ve got a “fix” shortfall of 1.2 million loans on new defaults recorded during 2009 alone. Short sales will help cover some of this gap, absolutely—but as I’ve written before, I do not expect them to be the panacea that many are currently predicting. Regardless, the point here is that there remains significant distressed housing inventory yet to be cleared off the books—and cleared off the books it must be, one way or another. Which means whether REO or short sale, these properties must eventually come on the market and be sold to somebody in order for there to be recovery. With that as background, take in recent remarks by the National Association of Realtors’ chief economist Lawrence Yun, discussing January’s 7.6 percent monthly drop in pending home sales: “We will see weak near-term sales followed by a likely surge of existing-home sales in April, May and June,” Yun said in a recent press statement. “The real question is what happens in the second half of the year. If there is sufficient job creation, housing can become self-sustaining with stable to modestly rising home prices because inventory has been trending downward.” Because inventory has been trending downward. Read Yun’s quote again, and focus on that very last phrase. Given the numbers I threw out earlier in this column, we’d all better think about what millions of distressed sales will do to inventory, and prices too. We’d better start doing something that the NAR is famously horrible at: considering the supply side of the housing economics equation, rather than simply looking at ways to juice housing demand (read: generate commissions for dues paying NAR members). And speaking of housing demand, I’m not sure how higher mortgage rates tied to the Fed’s exit from mortgage purchases coupled with a pending expiration of the homebuyer tax credit will translate into an expected “surge of existing-home sales in April, May and June,” as Yun asserts. Both changes to the mortgage market’s inner workings are scheduled to hit in April. More impartial economists than Yun are watching April as a critical month for U.S. housing. Mark Fleming, chief economist at First American CoreLogic has said that “[t]he big unknown for the 2010 spring selling season continues to be the future of the federal homebuyer tax credit.” I agree insofar as demand for homes goes, but my concern sits more squarely with the supply side of the housing equation—what, exactly, becomes of millions of units of already distressed residential housing? To understand the depth of the problem here: we’ve already got 4.7 million loans either 90+ days delinquent or in foreclosure, according to LPS data. I could legitimately argue that at least 25% of that figure should already have been listed on the market as inventory to be sold via REO or short sale (after all, the average age of a loan in foreclosure is well over one year). The NAR estimates that there are 2.8 million single-family existing homes available for sale, representing a 7.6 month supply at the annualized, seasonally-adjusted sales rate recorded in January 2010; add the 25% figure I describe to that, and we might in reality be closer to an single-family inventory figure of 4.0 million and 11 months supply. Here’s the bottom line: any so-called recovery in housing right now is a faux recovery until we work through bloated distressed inventory levels. The sooner we get to work on this, the sooner we get ourselves a long-term and sustainable recovery in U.S. housing. Paul Jackson is the publisher of HousingWire.com and HousingWire.com. Follow him on Twitter @pjackson.