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When will the Sub-Prime Problem Be Over

By: Steve Johnson

3/5/2008 - 15 Comments

Sub-prime loans are the loans given to people with bad credit or without the financial means to pay their mortgages when their interest rates reset. 

A large part of the housing market decline is because too many sub-prime loans were given out in 2005-2006. The market has always been able to absorb a small percentage of sub-prime loan foreclosures, but the number of sub-prime loans given out was ten times more than the market can handle. A majority of these sub-prime loans are now going into foreclosure as the owners cannot afford the payments after they are reset with higher interest rates.

The majority of the sub-prime loans given out in 2005-2006 will not be reset until September of this year.  Therefore, the housing market is not likely to stop declining until these have been cleared through the market – and what I mean by “cleared through the market” is they have been foreclosed and sold. 

 

Reference Article: The Federal Reserve's rescue has failed

The End in Sight

The foreclosure process can takes up to 12 months, so the housing market will not be free from the burden of these homes until mid 2009. If I had to guess at when the housing market would finally stop dropping and start to level off, I would put it at about mid 2009. This is not the end of the problem, but at least the beginning of the end. 

The massive amount of foreclosures that have flooded the housing market with homes have created an unequal supply/demand relationship – which everyone trying to sell a home has become a victim of. The rapid increase in suppy has forced a drop in average housing prices, which has created many other problems; most pronounced is the effect on consumer spending – which supports 75 percent of the US economy. 

This is the big one – the problem no one anticipated.  And it has become a global problem as the Federal Reserve’s solutions to lower interest rates and print money as fast as they can, has resulting in the exporting of inflation around the world.

The Federal Reserve has already cut interest rates by 1.25 percent and could soon be cutting them to zero.  So far, they have had little effect because the public is so entrenched in personal debt and very little savings – there is little they can do without their housing prices re-inflated back to the levels they were two years ago.

Realizing the predicament that the public is in, the Federal Reserve has deferred to plan B: dropping money from the sky in the form on tax rebates. But, a $600 rebate does not compare to a $20,000 lost in home value. Therefore consumers are likely to continue to pull back.

The Recession

Time will tell when the housing market will return. If it takes three years to get to the bottom, it will likely take six to eight years to return to peak prices. That could put the US economy into a ten year recession, much like the 70’s recession – with high inflation and high interest rates.

In the end, the US economy will be better off – as we always are after a recession. But, it’s going to be more fun coming out of the recession then going into it. 

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