If the current economic news isn’t scary enough, two respected analysts have come up with Doomsday scenarios that are guaranteed to terrify you.
Here’s one from Mark Gimein, who writes for Slate.com.
Gimein argues that the subprime crisis is going to spill over into prime loans, greatly expanding both the reach and the consequences of the mortgage debacle and the housing price meltdown.
What’s coming, says Gimein, is a “wave of interest-rate resets in prime loans given to people with good credit that are just as bad, or worse, than we’ve seen in subprime.”
The effect wil be that many thousands of upscale homeowners will walk away from their homes (and their loans), causing even greater loses for lenders and an even greater fall in housing value. Another effect: no federal bailout will be able to prevent the total collapse of the housing market.
Here is his reasoning:
“When those dominoes start falling next year [as ARMs reset to higher rates], we may or may not have a subprime bailout plan, and the discussion will start about how to bail out this next tranche of borrowers. The bailout plans on the table now…are reasonably based on the principle of bringing payments down to a point that homeowners can afford.”
“But where prices fall 40 percent to 60 percent, all that goes out the window. Why? Because in expensive locales like San Diego, tens of thousands of people with 100 percent loan-to-value mortgages and option ARMs are living in homes in which they have no equity and on which they owe a lot more than the house is worth.”
“In these places, accepting a government “bailout” that pays them, say, 90 percent of the value of the house to keep from foreclosing will be very tough for lenders, who (if the appraisers don’t fudge the numbers) could be forced to take 36 cents or 45 cents on the dollar for their loans. On the other hand, any plan that makes them pay more if they can afford it is hugely disadvantageous for the borrowers, who have option ARMs about to reset and are much better off handing the keys to bank—and maybe even scooping up the foreclosed house down the street.”
“If you’re…in this position, you might start thinking very seriously about just how attached you are to the wisteria vine snaking over the basketball hoop on your garage. That’s what a lot of other California borrowers will be doing.
“Bet on this: Whatever moral qualms are being urged on borrowers to keep them from walking away from their mortgages, they’ll count for a lot less than the economic reality facing borrowers whose homes have fallen in value by half. Lenders had no reservations about selling borrowers loans with rising payments that would be poisonous in a rising market. Now it seems borrowers have no reservations about leaving those lenders with the risks they begged to take.”
“Consider, too, that, yes, going through a foreclosure kills your credit rating and makes it a lot harder to buy a new house—but as more and more prime borrowers go into foreclosure, it’s perfectly possible that buying a new home a year later will in the near future be as routine and unsurprising as the once inconceivable idea that you can get a whole batch of new credit cards two years after a bankruptcy.”
If that scenario isn’t chilling enough, Yale University economist Robert J. Shiller (author of Irrational Exuberance and co-developer of the Case-Shiller home-price index) has warned that the current housing crisis could exceed that of The Great Depression.
Specifically, Shiller announced that there’s a good chance housing prices will fall further than the 30% drop in the historic depression of the 1930s.
“I think there is a scenario that they could be down substantially more [than in the Depression],” Shiller said in a speech spech given last week at the New Haven Lawn Club and reported in the Wall St. Journal.
Here is Shiller’s reasoning:
Even normal real estate cycles typically take many years to correct. Because home prices rose about 85% from 1997 to 2006 adjusted for inflation in the biggest national housing boom in U.S. history, the current downturn is likely to go much deeper and last far longer than any other has in the past.
“Basically we’re in uncharted territory,” Shiller said. ” It seems we have developed a speculative culture about housing that never existed on a national basis before.”
As for us, we’re not quite ready to evaluate either Gimein or Shiller as credible prophets of doom.
We note that, while widely respected, Professor Shiller has also been called the “Dr. Doom” of the U.S. economy.
And we think that both the Pollyannas and the scaremongers have usually been proven wrong. Economic life usually operates between the poles of perfect success and catastrophe.
But not always.
If you’ve got something to say to help us all sleep at night, please let us know.
Until then, pleasant dreams…
THE FOX REPORT 