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Apocalypse Now?

Posted by: Dean Foust on March 16, 2007

No secret that subprime is the story of the day. A Wall Street Journal story from today (registration required) said that economists polled predicted subprime would depress housing activity this year, but wouldn’t create a recession.

But there is a school of doomsayers who argues that Armageddon lies ahead—that the loose credit conditions that lead to the subprime mess was the tip of the iceberg, and that we’re headed not just for a recession, but possibly even a depression. That’s the view that this blogger, Bill Cara, takes in this recent piece. (If you’re wondering, ‘Who is Bill Cara?,’ he provides his bio here.)

To quote Cara: “…Yes, I believe there will be a US economic recession, but the elements are now in place for the first time in 80 years for America to sink into a depression. Should a depression unfold, there will be big name financial houses that will fail. Accordingly, the owners and managers of wealth ought to be researching today how to protect themselves beyond FDIC-insured accounts…”

Cara throws a lot of tables at the reader to make his case that the subprime mess will not only cause a recession, but that we may be hurtling toward a depression. I admit that there are some issues facing America that concern me — namely, the mountains of public and private debt, plus the unfunded liabilities — but I’m not convinced that he makes his case here, and for these reasons…

To be clear, I'm not denying that we've got a subprime mess that is ugly, and could impact not just a lot of financial players (including the big Wall Street investment banks like Merrill and Bear Stearns) but also the economy. And admittedly, the charts of subprime activity all look scary -- subprime loans in 2006 supposedly represented a high percentage of all loans, and of all lending volume. But there are few hard numbers numbers here that show me what percentage of all loans outstanding are subprime, and what percentage are delinquent or even facing foreclosure. What percentage of all households have facing foreclosure? I have a hunch that the real number of subprime loans is less than we're being led to believe.

Reason? Churn. We read a lot about how aggressive mortgage brokers put low-income borrowers into subprime mortgages they couldn't really afford, and then when, inevitably, they started missing payments, they refinanced them right back into another loan. So I think there's a lot of double-counting, and perhaps even triple-counting going on, as some subprime borrowers took out two and perhaps even three mortgages in the course of a year.

What do you think? I'd like to get a discussion started here. Recession? Depression? Or just a really bad case of the flu that passes by the end of the year?

Reader Comments

Graham Reaper

March 17, 2007 10:04 AM

President Clinton on November 1999 signed the Graham-Leach Bill which rescinded the Glass-Steagall Act of 1933.The Glass-Steagall Act put in place banking controls to prevent the mistakes that lead to the last Great Depression. What makes us exempt from same fate of an unregulated and over-leveraged financial system?


March 17, 2007 11:18 AM

Putting your head in the sand is not going to make this go away.

I suppose the people who control the "real" money will go running to China, they don't understand what a commie is, but are soon to be educated.

John Davis

March 17, 2007 2:39 PM

Recession? Definately? Depression? A good chance. Interested readers should get a copy of "America's Financial Apocalypse: How to Profit from the Next Great Depression." This is the best and most detailed book on the topic and it covers numerous issues like debt, real estate, health care, Social Security, pension problem, oil shortage. All of the other books on the topic can't hold a candle to this brilliantly-researched book.

Jim D

March 17, 2007 5:26 PM

The only chart you really need is from your magazine:

But watching subprime misses the real story, which is that housing prices are going very, very far down, as they once again reach for historical levels of affordability. For San Jose, where I live, that's a 50% drop in prices.

Will a drop to historic levels trigger a recession? How could it not?

Will it trigger a depression? Well, what triggered the last one? Massive debt writeoffs, wasn't it?

John Vanhara

March 18, 2007 12:04 PM

I read Bill Cara's blog and very respect his opinion. That is making the whole situation even more scary. There are definitively too many people who bought homes they cannot afford. I know many people personally who with family income of less than $40,000 bought not one, but three, four or even five homes (each in $300k range). What I am writing about is situation in Las Vegas, NV, where the speculation was probably higher than anywhere else, but it really sounds very scary what will happen.


March 19, 2007 12:58 PM

Looks like you have collected the usual group of doom and gloomers praying for a housing bust. Ben Stein at CBS said the truth yesterday when he said:
"This whole subprime mortgage mess is just an excuse for the gunslingers and river boat gamblers on Wall Street to use their tricks to move markets and make money. The economy is still very strong. The most cagey players on Wall Street like Goldman Sachs are now trying to buy — not sell — as much distressed merchandise in the mortgage area as they can. This is a good clue about where the smart money is going.
You can panic if you enjoy being panicky. But this will all blow over and the people who buy now, in due time, will be glad they did."

Jim D

March 19, 2007 5:48 PM

Frank wrote:

You can panic if you enjoy being panicky. But this will all blow over and the people who buy now, in due time, will be glad they did.

Tell it to Cisco. After all, it went so far down, must be a good buy now, right?

It's telling that the people who argue against the possibility of financial crisis usually ignore the facts presented by those who think it possible, instead relying on the fact that it hasn't happened in a while, or on false appeals to authority.

Michael Hoskinson

May 10, 2007 11:00 AM

As a real estate broker with over 20 years of experience, I wanted to weigh in on the current sub-prime debacle.

In this last housing boom, lenders created loan products to meet consumer's hearty desires, they created a huge amount of equity but missed a vital point; they allowed consumers to buy a payment, not a house. Items like "Stated Income" and "Hybrid ARMs" made an egregious amount of money for banks and brokers but put people in places they should never have been allowed to go. The sad part is that the public will end up paying for the lender’s mistakes.

One of the biggest problems is how the market defines "sub-prime", they label it as 640 FICO or less. One 30 day late can unjustly bring you to that level, to use that against borrowers is criminal. Banks have been manipulating borrowers with excellent credit so that they can put them into lousy loans that make the bank a ton of money but place the borrower into a larger payment that is built to fail sooner or later. If the credit scoring mechanisms (FICO) were realistic and banks rated a borrower's credit correctly, allowing for mistakes and some unavoidable items, it would result in borrowers being put into the proper loans. Banks would have made a bit less money but not bankrupted their customers eventually. It is a system in which the borrower has very little leverage; you play on the bank's field or you go home……..if you have one.

Of vital need for change is the way loan brokers are compensated. The YSP or "Yield Spread Premium" is nothing more than the Bank's kickback to the broker for doing the loan. The worse the loan, in terms of interest rate, that the broker gets the borrower to agree to, the higher the YSP dollars go to the broker. What exactly, other than honesty, is the broker's motivation for helping a borrower get the best available deal? Combine greed, low barrier to entry and minimal mandated disclosures and you have a recipe for a lending disaster at the borrower level. Until there are mandated disclosures that spell out, in 14-point type and plain language, what exactly a borrower is encumbering themselves to in total and how the broker or bank is compensated this system will continue to fail the public.

I have personally seen lenders and brokers lie to consumers about their credit-worthiness and play bait-and-switch games to get them into appalling loans. The residential industry is rife with such tactics and their bill is coming due for it. They killed their own Golden Goose; we're going to get stuck with the feathers.

Michael Hoskinson
Foundation Realty
Huntington Beach, Ca

D Fish

October 10, 2008 5:35 PM

Much has happened since you wrote this article...

what do you think now? Seems pretty real to me.

We are a bankrupt nation whether we want to face the facts or not:
http://en. wikipedia. org/wiki/List_of_countries_by_current_account_balance

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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