![]() ![]() These are steps in the right direction, but they will not help the vast majority of the subprime homeowners at risk of losing their homes. President Bush has proposed measures that would encourage lenders to renegotiate mortgage terms to allow people to stay in their homes and would provide additional support from the Federal Housing Authority. But we can implement policies to get the economy on the right track.įirst, it is important to protect the subprime home buyers who were tricked into taking out mortgages they could not afford. Since housing wealth is far more evenly distributed among households than stock, it will be even harder to recover from the housing crash than the stock crash. ![]() As former Federal Reserve chairman Alan Greenspan discovered in 2002, it is not easy to boost the economy out of a recession caused by a burst financial bubble. Throw into the mix declining state and local tax revenues due to the loss of construction fees and property taxes, and you have a further source of bad economic news. ![]() The basic story is a downward spiral as the housing sector interacts with the rest of the economy: lower house prices, more foreclosures, fewer jobs in housing and less consumption, a weaker economy and less demand for housing. ![]() With record numbers of unsold and vacant homes, it is difficult to see how prices will stop falling anytime soon. Formerly supercharged markets like Las Vegas, Miami and San Diego are experiencing double-digit price declines, while the slightly less bubbly markets of New York, Boston and Washington are seeing declines in the single digits. While this is an extraordinary decline, the reality is almost certainly much worse than the data show, since many of these contracts will fall through because buyers can't get mortgages. This showed up starkly in a 12.2 percent drop in the July pending sales index, which measures the number of sales contracts signed each month. Mortgage credit has frozen up for all but the safest loans. This is why the subprime crisis is leading to failures of banks and funds in France, Germany, Australia and elsewhere. In the current market, the mortgage issuer typically sells it off in the secondary market, where it becomes the basis for mortgage-backed securities that are then sold throughout the world. Banks used to hold the mortgages they issued, which gave them a strong incentive to be careful (often too careful) not to issue a mortgage the borrower could not pay. The subprime scandal would not have happened if the mortgage market had not been transformed over the past quarter-century. This is leading to a huge wave of defaults and foreclosures - which is just beginning, as homeowners who took out mortgages in 2004 are now hitting their three-year mark. Millions of families who could afford the teaser rates cannot possibly afford the higher rates. The worst of the speculative financing was in the subprime market, where moderate-income home buyers were persuaded to take out adjustable-rate mortgages, which generally feature very low "teaser rates," typically reset after three years, often to levels that are five or six percentage points higher. economy from the stock crash recession of 2001. The housing bubble in turn fueled the recovery of the U.S. Investors, after losing much of their wealth in the stock crash, viewed housing as safe. While the two bubbles burst simultaneously in Japan, in the United States the stock collapse actually fueled the growth of the housing bubble. housing bubble coincided with its stock bubble. There was no change in the fundamentals of supply or demand that could have explained the rise. It should have been clear to economists that this run-up was being driven by a speculative bubble. Since 1995 inflation-adjusted house prices have risen by more than 70 percent. For a hundred years, from 1895 to 1995, house prices nationwide increased at the same pace as the overall inflation rate. House prices rose at an unprecedented rate over the past dozen years. The downturn should not have been a surprise. (When it comes to recessions, the professionals seem to be the last to find out: On the eve of the last downturn, in the fall of 2000, all the Blue Chip 50 forecasters predicted solid growth for the following year.) Most forecasters insist there won't be a recession, although the August job losses forced even optimists to acknowledge that the meltdown is causing serious economic problems. The housing market is in its worst downturn since the Great Depression - and it's taking the rest of the economy down with it.
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