The sub prime mortgage meltdown

Posted at 1:43 PM, Mar. 5, 2007

In case you have not heard the news, a brief recap is in order.

Earlier today the WSJ published that, New Century Financial will be unable to continue operations. New Century Financial is a real estate investment trust, or REIT, that operates one of the nation’s largest mortgage finance companies.  By some metrics New Century Financial is considered the second largest sub-prime lender in the USA. This adds to concerns that began earlier this year when HSBC Holding, the world's third largest bank by market value, indicated that it was encountering problems with its sub prime mortgages.

While this is a major concern to investors, what effect will this have on someone purchasing or selling their primary residence?

Generally speaking, it will reduced demand for housing as those who may have been able to get loans previous to these events will no longer be able to do so in the new lending environment.  Basically, credit will became tighter, at least for those not qualified for prime loans.  Interest rates are not likely to change for those with a long history of good income and who have a good down payment or substantial reserves.

The pressure on home prices, at least at the entry level, will continue.  However, I still don't expect a substantial decrease.  Why?  Employment.  Those with income, don't suddenly stop making payments on their home.  Only if employment or income drops materially will I expect a substantial decrease in home prices. 

This is not just theory.  One only has to look at the state of real estate near Dearborn, Michigan to see how these forces play out. Michigan has been hard hit for many years by the turmoil in the auto industry. Yet not all areas of the state are doing equally poorly.  Areas like Grand Rapids with a relative diversified employment base has fared much better than other areas of the state.

Is this the beginning of a housing lead recession?  I discussed the factors that may led to a housing led recession previously at http://tchamplin.realtownblogs.com/housing-led-recession/.  It all comes down to how many people in the aggregate will be forced to reduce their spending because they lost their home or in order to make their mortgage payment.  If a relative few are effected then the broader economy, aggregate income, and employment will not be materially effected.  If a substantial number are effected then this could get ugly as income and employment fall causing spending to fall causing income and employment to fall more.

If you want an honest discussion that will help you decide if now is the right time for you to buy or sell, please contact me.