Reassurances on the Housing Bubble

The Times had an interesting piece discussing the impact of more than $1.2 trillion in adjustable rate mortgages resetting in the next two years. The article points out that many homeowners may find their rates increasing by as much as 2 full percentage points when their lock-in period ends on an adjustable rate mortgage.

The article notes that this increase in mortgage payments may cause serious distress for many homeowners and may even lead some to give up their house, especially if it has lost value since the mortgage was issued. However, the article assures us that the situation will not pose any problem for the mortgage banking industry.

How do we know it won't pose a problem? Well the industry said so. That pretty much settles the case. After all, if they were seriously worried, the representatives of the industry would no doubt be anxious to have their concerns prominently displayed in the New York Times.

I have written on the housing bubble at length (see our site), but I'll just give two quick items to unsettle the comfortable. First, to make the case that there is no problem, the article comments that "mortgage industry losses of $110 billion spread over several years would amount to a mere 1 percent of the total national homeowners' equity of $11 trillion." I am not sure where the $110 billion figure originated, but loses of this magnitude would certainly take a very serious toll on the mortgage banking industry. The relevant denominator is not the amount of homeowners' equity, but the net worth of the banks in the sector. Without checking the books, I would be confident that their net worth is considerably less than $500 billion. If losses in the sector go over $100 billion, even spread over several years, then it is virtually guaranteed that you will see some major banks facing serious problems.

The other cause for concern is that economists seem to have a very difficult time seeing bubbles or assessing the impact of their collapse. In September of 2000, not one of the 50 "Blue Chip" forecasters predicted a recession in 2001. The lowest growth projection from this group was 2.2 percent. Given the stock market crash was already in progress, it shouldn't have required too much insight to see problems down the road. I doubt that the quality of economic forecasts has substantially improved in the last six years.

--Dean Baker

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