Yes, Housing Will Get Worse. But How Bad?
Two ways the mortgage mess might play out
How much worse can things get in the housing market? With mortgage lenders folding, home builders bleeding red ink, and foreclosures filling the "public notice" section, the answer might seem as ominous as the "price reduced" placards that increasingly top the for-sale signs now littering America's lawns.
After all, as the recent ugly credit crunch shows, capital is once again living up to its well-deserved reputation for cowardice. It's bold when there seems to be little chance of getting beaten up—such as the aggressive lending to even the least-qualified borrowers at a time when the value of their collateral (their homes) kept going up and up. But lenders seem to turn and run as soon as things get rough, holding back capital not only from riskier borrowers but even from those with sterling credit.
It's not hard to envision the resulting house of pain: Mortgage credit, the mother's milk of the housing market, suddenly dries up. Unable to secure proper financing, home buyers all but disappear from the market. Sellers drop their prices even further but still don't get offers. Unable to refinance, increasing numbers fall behind on their mortgage payments and eventually lose their homes, swelling the inventories of unsold homes and driving prices down even more. That, in turn, sucks equity from even the most prudent homeowners, further denting not only their confidence but also that of every investor who ever considered that buying a house, a mortgage-backed bond, or even a money market account was a safe bet. The resulting panic—like depositors' recent run on Countrywide Financial—could freeze lending not only to the housing market but to the entire business community, prompting a nasty recession.
Yet for all the panic the credit crunch has caused, most housing experts aren't convinced that the current misery in the financial markets will lead to the sort of vicious economic cycle that resulted in the last big housing downturn in the early 1990s. Back then, prices in some areas fell by 20 percent and more in real terms before bottoming out. Economists point to continued strong employment, global economic growth, and a financial system far more sturdy than when the federal government had to bail out hundreds of savings and loans.
Risk. Of course, few of them predicted the current mess in the credit markets, either—arguing instead that the broad dispersion of mortgage-backed securities and the advent of risk-hedging derivatives would spread the bets so widely that, although some might get hurt, few would lose their shirts. "That's the great irony of the situation," says Mark Zandi, chief economist at Moody's Economy.com. "The big advantage of all this financial innovation has been the diffusion of risk. But by doing that, we've made it more difficult to know who bears that risk."
And with that fear of the unknown driving what in calmer times would be rational financial decisions, it remains to be seen whether the housing market is about to go from bad to worse or is finally hitting bottom.
To help you hedge your own bets, here are two possible scenarios for how things could play out: