Just as it took the Fed and most economists an incredibly long time to discover the problems in the subprime mortgage market, it is taking them an incredibly long time to realize that the problems are not restricted to the subprime market. News stories continue to assert that the financial markets are worried about further write-downs of subprime debt. While lenders will take the biggest percentage hit on subprime mortgages (and Alt-A mortgages, which may be of lower quality), the absolute value of their losses may end up being considerably larger on prime mortgages. As BTP has pointed out hundreds of times, the underlying problem is falling house prices. Nationwide house prices are now falling at more than a 4 percent annual rate, with many cities experiencing double-digit declines. This means that many recent homebuyers now have negative equity, they owe more than their home is worth. Under such circumstances, many homeowners, including many with prime mortgages, will end up defaulting on their mortgages. This is why the financial markets are rightfully getting very worried.
--Dean Baker
