as banks are continuing to carry very large REO inventories, what is stopping them from just dumping them onto the market and creating excess inventory in the market and further depressing home prices?
The banks are not carrying large REO inventories. For more on that read: http://www.foreclosuretruth.com/blog/sean/reo-inventory-hidden-shadows/
The reality is that banks aren’t paying significant interest on they money they borrow (close to zero). When you get money at little to no cost, there is no motivation to rectify a non-performing loan. As a bank exec, you would rather loose a few basis points per year on a dead-end loan and push the actual foreclosure and loss into the future, after you’ve had your bonus. If the interest rates paid by banks went up to something ‘normal’ (like anytime during the prior century), you would see a very different reality.