Bubble, bubble...[housing trouble]

I've been hanging out a lot at the Angry Bear and other econ blogs lately, and I'm starting to get the feeling, my friends, that we're in for a world of hurt. There's been talk for months and months that the housing market is unsustainable. But now the gloomy sentiment is becoming mainstream. I heard not one, but two stories on NPR yesterday about impeding trouble in the housing sector. Prices in 'hot' markets on the coasts have gone completely insane. The housing boom was initially fueled by rock-bottom interest rates, but now speculation is rearing its ugly head, with 85% of condo sales in Miami going to investors. Meanwhile, even ordinary people are throwing caution to the wind and buying the most house they could, even if it means stretching themselves to the limit financially. They've seen their friends and family refinance their way to the good life, and now they want to get in on the action themselves, just as those who are in the know are starting to worriedly mouth the dreaded word -- 'bubble'.

With so many potential customers clamoring for home loans, the financial industry have come up with many new 'creative' products so that marginal clients who would have been turned away in staider times can grab their piece of the American dream. 35-year morgages. Interest-only payments for three or even five years. Despite historically low interest rates, people are eschewing fixed-rate morgages for adjustable-rate morgages because, in the short term, the payments are lower. You don't have to be Alan Greenspan to foresee that many of those American dreams are going to end in the nightmare of foreclosure and bankruptcy. The banks don't care because as soon as they make the loan they turn around and flip them to Fannie Mae and Freddie Mac -- government sponsored enterprises that buys the loans, no questions asked. Government sponsored -- meaning that if their overstuffed portfolios of questionable quality causes those quasi-corporate behemouths to go down, they're probably going to get bailed out with tax-payer's dollars.

With the handy timing of the bankruptcy bill, it is becoming well-nigh impossible for the average citizen to get out from under runaway debt through filing Chapter 7 and getting a fresh start. It cannot be emphasized strongly enough that even if the housing market somehow comes to a 'soft' landing (flattening out instead of crashing), an awful lot of people are going to get burned because they allowed themselves to be talked into morgages that are very bad deals in expectation that the housing market is going to keep zooming year after year and build equity for them. Meanwhile, interest rates are creeping up inexorably. Tick tock.

While it is overextended homeowners (especially recent homeowners) in currently overpriced coastal markets who are going to bear the brunt of the pain when the market re-adjustment comes, none of us are going to escape unscathed. We're in the midst of a shaky economic recovery where all the growth is in profits and productivity rather than jobs and wages. To put it another way, it is a recovery predicated on consumers spending more and more money that they don't have. This is only possible through increased debt, in part enabled by people refinancing their properties at inflated prices. I am more and more afraid that when the housing bubble pops, it is going to unleash a chain of events that plunges our whole economy into recession. Even worse, we just so happen to be in a financially precarious situation as a nation, with enormous budget deficits and unsustainably large current account deficits. If China gets tired of propping up the value of the dollar just as the housing market crashes, could we could be seeing a perfect storm of economic calamities resulting not just in a recession but a depression?

(Much thanks to Calculated Risk, whose posts at the Angry Bear and his own blog have done much to further my understanding of this issue.)