Tuesday, March 13, 2007


I got quite a few e-mails from you guys about the housing post I made in January, so I thought I'd do an update.

I mentioned subprime lending in January. Specifically, this:
Probably the most-disputed segment of the economy right now is housing. There was a massive housing boom in this country that lasted for years. It created so much additional liquidity in the economy, both from people selling their homes for a profit or taking out home equity loans, that it took on a life of its own. And like most booms, toward the end it was being sustained by all kinds of dubious tactics--most notably, the gigantic increase in sub-prime and "alternative" loans.

The discussion about lending could be book-length in itself, but suffice to say that quite a few people have taken out home loans that they will only be able to pay off if their homes increase (rapidly) in value. And there are serious concerns that as more and more people default on those loans, they'll take sub-prime lenders with them (already happening), have a ripple effect on the availability of credit, and lots of bad things could happen from there.

I mention this again because the tone of the discussion has changed since January. Today, for seemingly the first time, the market is down hard in response to concerns about the subprime situation (Dow, S&P, and Nasdaq all down over 2%). And instead of everyone claiming that the subprime lending problem is a "contained" problem, with no spillover for the rest of the economy (which was entirely delusional), most are now admitting that there will indeed be collateral damage, but that it won't lead to a recession. I think that's about a 50-50 proposition right now, based on the yield curve, but people are finally waking up to the fact that this could be a nasty, nasty problem.

Think about it. The whole premise of subprime lending is that people will default on a home loan only as a last resort. If that's true (and I believe it is), if you look at the skyrocketing rate of mortage defaults, it could be concluded that those people defaulted on everything else first: credit cards, car loans, etc. And don't forget that it wasn't easy credit just for home buyers--it was easy credit for everyone to buy everything.

Easy credit, combined with ATM homes, created huge amounts of liquidity in the system, but the only way that liquidity could be "kept alive" was through unsustainable means. Now, though, liquidity is being reigned in as the subprime lending market collapses, and that contraction of liquidity is going to have ripple effects everywhere.

There's lots more, because this is like a shiny apple that's filled with worms inside, and we could have another full discussion just dedicated to bubbles in general, but just remember this: the next time you hear some talking head saying it isn't going to get any worse, it's very likely that he's wrong.

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