The Coming Mortgage Meltdown

There are a few signs that the United States is going to have a collapse in mortgages, that is, millions of people are going to face foreclosure or a sale of their home for less than they owe on it.

Here are some sobering numbers. Comparing the first six month of 2006 to the first six months of 2007, the number of foreclosure filings increased by 58 percent. Interest rates have slowly climbed upward for the last year and that has been very damaging to millions of people who pay on adjustable rate mortgages, or ARMs.

How did we come to this precarious state? There are a few reasons. Mainly it is the mixture of liquidity with speculation. The bull market in housing that really began in 2000 has been quite a strong run. Overall, the nation's real estate prices increased about 55 percent in the seven years from 2000 to 2007. Many hot markets, like San Diego, Las Vegas, Phoenix, Honolulu, most of California and all of Florida. As a whole the prices of housing rocketed upward for the first few years of this century.

The reality for the finances of most people surprisingly didn't correspond well with this run-up in pricing. One would think that these higher prices would indicate people are doing better, but there is an entire different story when it comes to the financial state of America.

First, there are the salaries and wages. They are mostly flat for the time of this increase in housing prices. In some markets there was a mild gain, for example if you worked in automotive mechanics, then you saw an increase in pay of around 15 percent. If you worked in retail you most likely received a 10 percent increase in pay. The important concept to realize is that almost no one got an increase in pay that even begins to match the amazing increase in the cost of housing.

Second, the United States just doesn't have much equity these days. During the hot housing run millions of homeowners used home equity loans to pull billions of dollars out of their homes. They essentially treated their house like a credit card, only with a much better interest rate. People also began to borrow more heavily from other non-standard sources, like payday loan stores, the explosion of which demonstrates the need for debt by Americans. Another exotic loan device is that more people borrow from their 401k's than ever before. Finally, of course we have the ever increasing credit card debt.

Revolving debt in America, per the monthly number published by the Federal Reserve, indicates a constant increase in credit card borrowing. This is a financial problem because every dollar that is borrowed with such a high interest rate, it almost guarantees more people will be facing bankruptcy at some point.

The other big problem is that of speculation. Many people, probably in the millions, purchased residential properties in the hopes of making money. They treated buying extra homes the same as buying a stock, in that the purchase was strictly for speculation of financial gain. Buy low and sell it high. This worked great for a lot of people while the housing market kept chugging along.

Now that the slowdown in housing prices and sales has hit many of these speculators are facing financial calamity. Not only did they purchase the home with very little money down, but they are having trouble selling it for the amount they bought it for. Once you add in the property tax, cost of maintaining and selling costs, the speculator is in a situation where they will be losing money.

Adding all these situations together equals the pending meltdown in mortgages. People do not make that much more money than they did 10 years ago. Inflation has largely decimated that gain anyway. Meanwhile housing prices (along with food and energy) have continued to climb with abandon, until now. The great many people that own more than one home (the speculators) are losing money, and often facing bankruptcy.

The fire spreads. The number of workers who have lost their jobs due to the downturn in housing has already made a mark. Lenders, banks, appliance manufacturers, contractors, construction workers, real estate agents and many others that work in direct relation to the housing market have lost their jobs or are at risk of losing their job.

The financial losses begin to appear for large companies as well. One example is American Home Mortgage Investment Corp. just recently laid off nearly their entire staff, about 7,000 people. This had been up until a few months ago, the 10th ranked mortgage lender in America. Now the company is bankrupt.

How demonstrative is the American Home Investment Corp. situation? Just look at the outcome. The people who worked at the company lost their jobs and now will most likely take a lesser paying job, assuming they find one. The investors in the company lost their money as the stock became worthless. Many of the people that took loans through this company will lose their homes through foreclosure or a firesale, either way resulting in financial difficulty for them. All the ancillary work that was done for American Home Mortgage Corp., from catering to office cleaning, all the supporting companies will lose that business.

The mortage meltdown will hurt a lot of us in America. It's not a pretty thought, but we should face the reality head on as a nation. Some in Congress have suggested funding to help alleviate the suffering, by providing direct access debt at much lower prices than the adjustable rate mortgages. This might be a good option.

The housing market and the US economy will recover, but the question is how much pain and suffering will take place between now and then?