Archives: 2007 July

A disaster has been brewing in the sub prime lending housing loan market for some time. Until recently there was optimism that the damage could be contained.

However, with the recent Bear Stearns hedge fund disaster it appears like the toxic circle of debt supporting more poorly collateralized debt is going to lead to some very unpleasant worldwide repercussions.

The entire lending industry has been drastically effected by the Alan Greenspan lead Federal Reserve liquidity explosion of the past several years. While Greenspan is no longer Chairman of the Federal Reserve his legacy of creating a true US Dollar fiat currency and easy money will be with us for a very long time.

For the past many years lenders seemed to forget that when you lead to people who have a very limited ability to repay trouble is sure to follow.

Trouble is for sure brewing now as a record number of homes are headed for foreclosure. As ARMs , Adjustable Rate Mortgages, are reset at much higher interest rates with the resulting much higher monthly payments, an army of borrowers are finding it difficult, if not impossible to replay their loans.

Look for much higher interest rates over the next couple of years as credit worthiness once again becomes a major concern for leaders.

For addition articles on credit markets and on investments in today’s dangerous environment visit our sister site Investment World Today.

Over the past several years a good many home owners developed the habit of frequently using what is usually their most valuable possession, their homes, as a sort of reverse piggy bank.

What I mean by this is that the widespread use of home equity loans made it all too easy to withdraw equity from homes. As long as the housing market was climbing by leaps and bounds each year this practice didn’t seem too unsound.

As equity was withdrawn from the home the good old housing market seemed to fill the piggy bank up again as the value of the home increased and equity was replaced.

Now that the housing market is falling into what may be very hard times indeed before a downturn is over the danger of overusing home equity loans is revealed.

If the cushion of equity has already been depleted due to home equity loan withdrawals and the value of a home decreases , the home owner can go underwater with his remaining equity pretty quickly. That is, the total loan balances on the home are greater than the home is worth.

If a forced sale of the home or foreclosure ever becomes necessary the home owner is left in a terrible position.

There is a place for home equity loans. They can provide cash for worthwhile purposes. However, the overuse of home equity loans for trivial purposes may lead to unfortunate situations when times become hard and housing prices are falling.

It is already too late to avoid a disaster in the United States housing market. The big questions now are how bad will it get and how long will a severe downturn last?

The problem is that the party is over in the sub prime loan lending market as home owners and borrowers who took out the risky loans over the past few years are faced with reset adjustments to their monthly loan payments that are far in excess of what they can pay.

Many of these borrowers didn’t fully understand the terms on these toxic loans at the time they closed on them. Borrowers who were delighted to take out loans requiring say $1,500 in monthly payments are now horrified to find their payments are being reset at nearly twice that amount.

Not only that but with many of these loans the outstanding balance is more now than it was when the loan was initiated. And that’s after making a couple of years of payments.

So what is the result of the sum prime loan debacle?

As sub prime market borrowers face sharply higher payments many are unable to pay. The foreclosure rate is already at record high rates and the number of loan resets already made are still in an early stage. As the real estate market is flooded with distressed properties the entire housing market is at risk of being dragged down.