by Dr. David Wiedemer
Co-author, "America's Bubble Economy"
In our book "America’s Bubble Economy" we promised you importantupdates on the book's web site. This is not a specific market update.Rather it is an update on an economic event that will effect allmarkets—stock, housing and the dollar. This update involves the muchdiscussed sub-prime mortgage meltdown and our take on it.
We feel that the sub-prime market problem is the pin to burst the housing bubble.The bursting of the housing bubble, as we said in the book, will putpressure on the economy and ultimately on the stock market; it willcollapse both.
The expected sequence of events is as follows:
- Sub-primeloans will fall dramatically in number by spring 2008 due to severeproblems in selling these loans on the secondary market. Alt-A or “nodocumentation” liar loans will be decreased dramatically for the samereasons, as we just saw with the collapse of American Home Mortgage.
- The lack of sub-prime and Alt-A funding will put downward pressureon prices and new home purchases. As we have mentioned previously, eventhough the total number of sub prime and Alt-A loans is only 20% of thetotal market, it is more than 60% of new home buyer loans and it is thenew buyers that set the prices for housing, not the people who alreadyown houses. This is an obvious but important fact that is often ignoredin discussions of the effects of the sub-prime meltdown.
- The fall in home prices will cause further problems with people whohave refinanced into adjustable rate sub-prime mortgages and will causea huge increase in foreclosures which we are already starting to see.It is hard for us to imagine that there won’t be at least 2 millionforeclosure filings this year. Given that only about 6 million usedhomes are sold each year, that’s a lot of foreclosed homes coming onthe market that will have to be sold, further pushing prices down.
- When price falls are big enough, say around 20%, new homeconstruction will fall dramatically and greatly affect the economy. Theamount of home equity loans will be falling thus reducing consumerspending. Some home equity loans will be lost entirely because there isnot enough equity to cover them, causing serious problems for mortgagelenders. The ripple effects across the economy will start to be felthard, unlike today when they are only beginning to be felt.
- These ripple effects will be strong enough to put the economy intoa mild recession. This will collapse the stock market to below 10,000over the next 18 months to 2 years and real estate prices will fall with it.
- The economic and market downturn will become severe enough thatdollars will start to flow at a much faster rate out of the US thantoday. This will raise interest rates, especially mortgage rates,causing a further decline in real estate and all this will furtherdepress the stock market. The decline in the dollar is the ultimatetrigger for the beginning of Phase II.
See America\'s Bubble Economy: Profit When It Pops
