WHEN THE CORRECTION COMES
July 13, 2005
In years past, people bought houses with substantial down payments; today they are buying them with virtually nothing down. Mortgage payments used to include a paydown of principal; today there often is none. People used to need good incomes and credit to get mortgages; today people with poor credit are buying houses they really can't afford. Consequently, there is much less of a cushion for banks should borrowers begin defaulting on loans, says Bruce Bartlett, a senior fellow with the National Center for Policy Analysis.
As with all financial bubbles, everything works as long as prices keep going up:
- People build equity quickly and may be able to "flip" a property for a fast profit.
- Others can use their equity to get easy cash through refinancing or second mortgages, which they may use for investments or conspicuous consumption.
But if prices fall even a little:
- Many people may quickly find themselves overextended, with investment properties that can't be rented profitably, mortgage payments that are rising automatically, and mortgages that may exceed the value of their property.
- At that point, they may decide to just walk away or declare bankruptcy, leaving lenders holding a lot of bad paper and in possession of real estate that isn't worth what was paid for it.
Bartlett says there are a lot of stresses and strains in our financial system right now resulting from the housing bubble, Fed tightening, large budget deficits and international financial imbalances. We might survive a threat from one, but not all. Sooner or later, there is going to be a correction.
Source: Bruce Bartlett, "When the Correction Comes," National Center for Policy Analysis, July 13, 2005.
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