Do Falling Home Prices Mean A Major Recession Is On The Way?

"For the first time since the 1920s, the bubble is nationwide, and it's been driven by four national forces. First, the decline in mortgage rates; Second, the loose lending practices designed to accommodate those who have been priced out of the market under conventional mortgage terms. We're referring here to interest-only Adjustable Rate Mortgages as well as option ARMs that allow borrowers to make even lower monthly payments that result in a rising mortgage principle, or "negative amortization."

Then there are unrealistically high property appraisals to justify oversized loans and the lack of full documentation that allows borrowers to overstate their ability to make mortgage payments. Lenders also accommodate financially-weak borrowers with high loan-to-value ratio and piggyback loans, which in effect finance more than 100% of the houses' prices.

...Housing is so important to the U.S. economy and the American dream that it's very hard to believe that a collapse of the size we foresee could occur without a significant reaction from the Administration and Congress. With a 25% drop in existing median single-family house prices nationwide, sales will fall 60% or more from their June 2005 peak. Many homebuilders will go out of business and lending will switch from smiling distributors of more-than-ample funds to chastened tightwads who won't lend to anyone except those who don't need to borrow. Delinquencies on subprime mortgages will probably double from their current 8% rate.

What might Washington do? So many mortgages have been securitized in recent years that investment risk has been spread beyond conventional lenders. But that doesn't reduce the damage of foreclosures to hapless homeowners. Washington may end up using moral suasion and good old money to encourage lenders not to foreclose and otherwise mitigate dire consequences for homeowners that would lead to even weaker house prices as foreclosed houses are dumped on the market."