Freddie Mac and Fannie Mae, the over-leveraged government sponsored mortgage finance companies,
are swimming belly up and will have to be rescued by the taxpayers in one form or another.
"Who could have know … ?"
Searching through the Moon of Alabama archives I found an exchange I had with anna missed back in November 2004 (typos corrected).
anna missed asked:
So I wonder what happens to all those (Bush) new and old homeowners if the interest rate is jacked up in some significant way to move the Fed debt down. With the housing market, in some measure, carrying both production, financing, and labor through the Bush economy, could rising interest rates create enough of a disruption to precipitate a major deflation in the real estate market? And what happens when people are faced with negative equity, and how does that effect their ability to secure future credit? And how could an import based, retail, and services economy survive such an evaporation of credit?
Should real estate held close to current value be dumped?
My response back then:
Some 50% of the mortgages in the last months were adjustable rates (ARMs). Their rate will increase immediately when treasury rates go up. People will have to default and quite a bunch of houses will be available on the market, subduing prices. With prices going lower more peoples mortgage will exceed their home equity. This could become a chain reaction with a very significant drop in house prices and lots of bankruptcies.
This may have effects in the banking sector (expect Freddie and Fannie to somehow go belly up).
If you want to stay in your house for the rest of your life and if you can pay your fixed rate mortgage rates without problems stay put. If you plan to move in two years or if you are not sure you can pay your future mortgage rates you may better look into renting a place for a few years and buy a house again when they become cheap.
But when will houses become cheap again? Should one buy now?
No. Knife catching is hazardous. The IMF did a study some years ago looking at twenty housing market busts in 14 countries since 1970. House price deflation from peak to trough was usually around 28% and took 4 years. It is likely that the house price deflation in the current bust will be bigger and take longer. I do expect a 40% price decline in average. It will take 5 to 6 years until the markets stabilize.
That the decline will take so long has political consequences. There is nothing anyone can do to prevent it or shorten it. The presidential election in 2012 will be about the declining economy just as the current one. The incumbent in 2012 is therefore likely to lose.