Economic analysts are now acknowledging the shake-up in the sub-prime mortgage market. Lenders had used ridiculously lax standards, and a high percentage of recent loans are now at some point in the foreclosure prcoess. However, the conventional wisdom assures us that this will only affect the sub-prime market, not the larger mortgage and housing market. I remain a skeptic. Consider that nearly 20 percent of the mortgages issued in the last two years fell in the sub-prime category. This is a large segment of the market. Now suppose that many of these borrowers can no longer afford to buy homes or at least must pay much lower prices. The homes that sub-prme borrowers would have otherwise bought are the homes that other potential buyers would be selling. Without the sub-prime buyers, many homeowners looking to move up will be getting far less money for their current home. This will affect what they can pay for their move-up home. Of course, mortgage lenders across the board are also likely to apply tighter standards, since the secondary market for poor quality loans is contracting now that investors realize that you don't make money on defaulting mortgages (see Gretchen Morgenson's fine piece). So, the bubble will continue to unwind. It remains to be seen how far and how fast, but the sub-prime market market will not collapse and leave everything else standing.
--Dean Baker
