Fear and greed: why the American housing credit crisis is worse than you think

International Economy, The, Spring, 2007 by Lawrence B. Lindsey

Moreover, new home buyers will still be able to access the mortgage market even if they have to pay a little more for the privilege. Houses can still be bought and sold, people will still be able to move if they get a job transfer to a new city, and the normal role of housing in our economy will continue. Housing may not be the great get-rich-quick scheme that some thought a couple of years ago, but it will still be a sensible asset for the great majority of American families to own and trade as their personal circumstances change.

Unfortunately, the real estate market up cycle was so dramatic that even under the most favorable assumptions, there are still going to be a lot of foreclosures. Consider some back-of-the envelope math. Roughly eight million mortgages were issued in 2006 of which 25 percent, or two million, were sub-prime. Remember, these subprime borrowers were people who were completely frozen out of homeownership before all of the financial innovations of the up cycle were put in place. Some estimate that 15 percent or more of these subprime borrowers will default. That is 300,000 families. Imagine that half of these get some kind of workout that allows them to keep their homes, despite the default. That still leaves 150,000 families that would be evicted.

Now if one were going to be positive about all of this, one would note that despite all the anguish, 1.85 million families who previously were not able to get a mortgage to own their own homes now could and will be able to keep those homes. But that is not the kind of story you are likely to see on the nightly news. A family being forcibly evicted as the three-year-old crying daughter clutches her doll is a much more compelling story. Moreover, it is of little solace to that little girl that six other little girls just like her will be sleeping comfortably in their own homes. Let's not kid ourselves that a turn in the credit cycle can happen painlessly. That is why the next step is to consider this "best-case" picture in more realistic political terms. Those 150,000 foreclosures amount to about 350 per Congressional district.

ENTER THE POLITICIANS, STAGE LEFT

Never mind that politicians in both parties have claimed credit for rising homeownership during the up part of the credit cycle. Never mind that politicians in both parties passed laws and promoted regulations that helped hard-wire the credit cycle. Never mind that the excesses of the up cycle inevitably created the conditions that will cause the down cycle. The fact is that 350 little girls clutching their dolls as they are evicted from their homes is going to be unacceptable to the Representative from that district.

In January I was invited by the Congressional Research Service to participate in their biennial briefing of the incoming freshmen members of Congress. Somewhat to my surprise, the biggest concern they expressed was not about immigration or taxes or the budget but about what they termed the "wave" of foreclosures hitting their districts. This was back in January when any such wave was almost certainly a ripple on a placid sea by historical standards, or in comparison with what is likely to happen in the next couple of years.