The Effects of a US Housing Market Crash

By: Sarah_Jones

House prices across the atlantic continue to tumble across the board, with the National Association of Realtors, reporting a price fall of 1.7 per cent last month to $225,000 (£118,000), while sales of existing homes drop 0.5% to an annual rate of 6.3 million. At the same time, ever more owners are being forced to put properties on the market as mortgage rates have steadily risen, further dimming prospects of an improvement in the short term. The total of existing homes on the market is now the highest since April 1993.

As house prices fall, there will likely be many more defaults on mortgage products, such as ARM (adjustable rate mortgages), which the US borrowers were not used to a floating interest rate instead having relied on fixed rate products, now as interest rates have risen to 5.25% from just 1% have seen a surge in foreclosures reaching some 116,000 in August, up 53% on a year ago.

In many cases this effect will be magnified due to the speculative derivatives contracts betting on house prices and mortgage packages. These will hit financial institutions across the globe, as the bad debts and derivative losses's mount.

The question we ask is what effect will this have on the US and global economy ?

The consumer has supported the US & Global economy during the past 5 years by withdrawing over $750billion in equity against rising house prices for consumption. The fall in house prices is likely to have a dramatic effect on consumption and therefore economic growth. Already the latest GDP figures show a halving in growth from earlier in the year down to 2.6% from 5.2%.

The roots of the current problem can be traced back to the stock market crash of 2000, when the Fed lowered rates 17 times to an unbelievable 1% to keep the economy sputtering along while the Bush administration dragged the US into war, and gave away a further $450 billion a year in tax cuts, resulting in large and growing budget deficits in each of the subsquent years. Rather than face the recession that should have followed the 2000 crash. Some 10 trillion dollars of this excess money supply flowed into US property doubling its value, and leading to the ever more debt taken on by the US consumer to finance spending.

Unfortunately, everything that happened in the boom years is likely to go into reverse, where the consumer reduces spending to pay the ever rising mortgage payments due to rising interest rates, whilst at the same time the value of their properties fall, pushing many households into negative equity. two thirds of the U.S. economy is dependant on consumer spending and some 30% of the jobs created since 2001 were as a result of the housing boom, the downturn is going to have devastating consequences for the US and global economy.

So what to do about it ?What is happening in the US is a warning shot of what to expect in the UK during 2007, the key lessons are to pay down debt, cut spending, and if your looking to sell, do it sooner rather than later.

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