Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Monday, September 19, 2005

Crazy Mortgages:
Will They Trigger the Housing Crash?

There has been an explosion of creative mortgaging in the past few years. This article has a superb explanation of each of them and how they work [thanks to MA for the pointer]. It also says,

A few years ago, so-called "nontraditional" mortgages were a mere sliver of the market (less than 3 percent by some estimates); a July survey by the mortgages Federal Reserve found that they now account for more than a quarter of new business at a third of the nation's largest home lenders.

That swift rise has industry observers worried.

"We're very concerned with how safe these products are," says Stu Feldstein, president of financial research firm SMR Research. "There's an awful lot of risk out there."

My own view is that the over-extension of credit for housing (presumably related to expectations that prices will continue to rise) will not cause the housing bubble to deflate; the trigger will be something else.

But as housing asset values begin to shrink in the affected areas, people who have these creative mortgages will surely feel the pinch. Their attempts to meet their monthly payments on homes that will no longer be worth as much as they owe will induce some people to walk away from them. As the repossessed houses hit the market, with lenders trying to recoup their bad loans, look for more downward pressure on housing prices.

I am still reasonably confident that this scenario will play out mostly in markets that have experienced skyrocketing prices during the past two or three years. The rest of us, who didn't experience nearly the same boom will also not see much, if any, of a crash, either.

But Gary Shilling, writing in Forbes, disagrees with my assessment [link from Calculated Risk (h/t to MA)]:

Today's boom is national in scope: low interest rates, loose mortgage-lending practices and investor caution over stocks following the 2000-02 bloodbath. Yes, today's boom is mainly on the coasts, but that's where the population and income are concentrated. When the U.S. bubble breaks, it will affect more families than the recent stock slump, since 69% of families own their abodes while 50% own stocks.

... This is a dire forecast. Still, a severe nationwide break in house prices could destroy enough net worth and spawn a big enough financial crisis to shift the good deflation of excess supply I foresee to the bad deflation of deficient demand.
Along the same lines, Paul McGowan thinks several major retail chains will go under soon because of a stall in consumer spending. I can readily imagine that some chains will go into receivership because they are already on the ropes; and one reason they are on the ropes has more to do with changes in retailing in general and less to do with any stall or downturn in consumer spending.

The housing bubble is only beginning to deflate, and yet consumer confidence has already plummeted, but David Altig is far less pessimistic than McGowan seems to be. I don't think I'm quite as optimistic as Altig is, but I'm not as pessimistic as McGowan because even while some retail chains go belly-up, others will be growing, and it is a mistake to look only at the failures in an economy..

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