Posted by: Kevin | October 11, 2007

More Bad Economic News

According to The Wall Street Journal, the overheating of the housing market fueled by sub prime lending continued well into 2006.  This means that struggles in the housing market will continue for quite some time.  Borrowers who gambled on adjustable rate mortgages are going to eventually realize that they can’t refinance because their mortgages are underwater. 

In that situation borrowers can attempt to renegotiate with their lenders to get relief on their mortgages.  The bank takes a loss on the difference between the balance of the mortgage and the actual value of the house.  The borrower has to report that write-down as income.  That works for an individual crisis, but what happens when you’ve got 10.3 million high-risk mortgages issued over the past 3 years, each with the potential to become a crisis?

How much of a problem are we looking at?  As much as $600 billion in sub-prime adjustable rate mortgages are due to adjust to higher rates in 2008.  During the housing boom, many borrowers took out adjustable rate mortgages with initial fixed periods of anywhere from 1 to 10 years (myself included).  The expectation is that the continued housing boom would enable one to refinance later and lock in a favorable fixed rate. 

The problem with that scenario is it doesn’t work when housing prices are declining, as they are now in many parts of the country (I got out just in time).  Either the bank takes the loss described above or the borrower goes bankrupt.  Either way more money is taken out of the housing market putting more downward pressure on prices. 

I’ll admit, I’m struggling to understand how this hasn’t spilled over into other parts of the economy yet.  People getting foreclosed on don’t make for good consumers.


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