- The Washington Times - Sunday, January 6, 2008

If there is a recession in 2008, the principal causes would undoubtedly include: the ongoing collapse in residential-housing investment; the worsening mortgage crisis, which has already been afflicting housing loans well above the subprime credit level and now threatens to engulf many more households that were once considered solid — i.e., “prime” — credit risks; the rapidly deteriorating home-equity positions of countless overstretched families that are witnessing their biggest lifetime investment — their homes — fall in value, perhaps precipitously; worldwide financial-market turmoil that is exacerbated by a solvency crisis; and the adverse effect on consumption that would almost certainly occur from a significant decline in the housing-related wealth of families.

It is no coincidence that all of these factors are interconnected with America’s deteriorating housing conditions, which have been caused by the deflation of the nation’s housing bubble. To gain a deep understanding of this rapidly evolving crisis, interested readers would be well-advised to consult the Calculated Risk Web site, a highly authoritative, objective, timely, informative housing-and-economics blog. In a summary year-end post replete with graphs and figures depicting decades of housing and mortgage data, Calculated Risk reported the following trends:

• Each of the four recessions before the 2001 downturn (1973-1975, 1980, 1981-82 and 1990-91) was preceded by a significant decline in the seasonally adjusted annual rate of new-home sales, which has fallen from nearly 1.4 million in mid-2005 to less than 650,000 in November.

• Among the 51.2 million households that had residential mortgages in 2006, an estimated 5.6 million had no equity in their homes at the end of 2007. By the end of 2008, based on reasonable trends in housing prices, that total could nearly double to 10.8 million households. If housing prices eventually decline 20 percent or 30 percent from their peak values, the number of households with zero or negative equity would soar to 13.7 million and 20.3 million, respectively. These are stunning numbers that suggest that literally millions and millions of families could feel compelled to simply walk away from their mortgages once they become “upside-down,” which occurs when they owe more than their houses are worth. A 30 percent decline from peak housing prices would shave about $6 trillion in equity from family balance sheets, delivering a devastating blow to retirement prospects for millions of workers.

• Since early 2005, the mortgage-delinquency rate has jumped by a third, rising from 4.3 percent to nearly 5.7 percent, which is comfortably above the cyclical peak rate reached during the 2001 recession. Calculated Risk reports that “delinquencies are getting worse in every category — including prime fixed-rate mortgages — and getting worse at a faster rate in every category.”

• The housing deluge could be long-lasting. In an eye-popping Credit Suisse chart that Calculated Risk (CR) reproduced in October from the International Monetary Fund’s report titled “Assessing Risks to Global Financial Stability,” one of CR’s favorite themes — “We’re all subprime now” — became instantly clear. Remember the panic that erupted late last year as the initial teaser interest rates were resetting for the first time on about $20 billion in subprime mortgages each month? Well, the Credit Suisse chart revealed that an average of nearly $30 billion in non-subprime mortgages would experience interest-rate resets (i.e., major increases) each month during 2010 and 2011. The vast majority of these mortgages are either held in agency (e.g., Fannie Mae or Freddie Mac) portfolios, which are implicitly (though most definitely not directly) guaranteed by the U.S. government. Or they held elsewhere (commercial banks, investment banks, hedge funds, etc.) as prime loans, Alt-A loans (which fall between subprime and prime) or optional adjustable-rate loans (a potentially catastrophic category that initially allows homeowners to make monthly payments that are significantly less than the mortgage’s interest-only component, leading to negative amortization).

In the highly plausible event that housing prices decline well into 2009 and beyond, especially in bubble regions, many of these once-solid resetting prime loans could easily look worse in 2010 and 2011 than subprime loans look today. The optional adjustable-rate loans, which comprise the largest block of resets in 2010 and 2011, will implode if prices fall another 15 percent or more.

The accelerating housing and mortgage crises will almost certainly play much larger roles throughout the presidential and congressional elections.

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