Subprime Mortgage Crisis Could Spell Economic Downturn

Posted on November 26th, 2007 by saman

The worst case scenario resulting from the current subprime mortgage crisis is anybody’s guess right now, but many government and industry experts say it could be very, very bad. One chief investment officer of the world’s largest bond fund recently stated that, “its effect on consumption, its effect on future lending attitudes, could bring us close to the zero line interms of economic growth” and that worrying about it keeps him up at night. Zero growth would take the current unemployment situation to 6.4%.

More than 2-million homeowners now hold $600-billion in subprime adjustable rate mortgages (ARMs) and they’re due to reset at higher amounts sometime during the next eight months. Not all of these loans are in trouble, but homeowners who do default or lag behind in their monthly mortgage payments could cause an economic shock that hasn’t been seen in America since the Great Depression of the ‘20s.

Some of the finest financial minds project a scary scenario. They say that the next wave of foreclosures would not only force homeowners out of their homes, it might also affect the entire economy in a seriously-negative direction. The already seriously-depressed housing market would definitely be exacerbated when even more empty homes flood the market, resulting in a price drop by as much as 40% in once red-hot locales such as California, Nevada, Florida and Arizona. Some major homeowners have already gone out of business and many others are holding on by cutting asking prices to the bone. If the worst happens, the 10 global banks that repackage home loans into exotic securities like collateralized debt obligations (CDOs), could be forced to take far bigger write-offs than the $75-billion they already took this year.

If that’s not enough, there could be massive job losses that would put the reins on consumer expenditures that account for two thirds of our economy. The U.S. Department of Labor estimates that nearly 100,000 financial services jobs related to credit and lending in this country have already been lost. Thousands of Americans who now work in the housing industry could find themselves unemployed. There would also be a meaningful negative effect on car dealers, retailers and others whose jobs depend upon consumer spending.

There is certainly convincing evidence that another downturn is in the works. For one thing, borrowers who took out loans during the period January-June of this year are already beginning to fall behind on their payments. This, in turn, is making it even harder for prospective buyers to obtain new mortgages which bodes very poorly for current developers and homebuilders. Data suggests that more Americans than ever before could lose their homes and many of those are people who never expected to default on their house payments. They are solid people who were enticed by mortgage terms they just couldn’t refuse being hawked by expert salesmen.

Our modern financial system is interconnected. Mortgages are sold to investment organizations who then cut them up and package them into securities based upon risk. Then, the hedge funds and pension funds buy them up. Thus, the continued crisis could take them down like a house of cards in a stiff breeze, It’s not a pretty picture at best!