Our Worst Nightmare: Puncture of the Housing Bubble

Just read this superb Resource Investor article. It puts into perspective the potential ramifications of a housing bubble bust. The article is a rather long read, but well worth the time spent. I must warn you however, that it paints a downright scary picture for the future of our economy.

Here are a few snippets:

The key to holding up the entire speculative U.S. financial system with its current excessive levels of debt - federal (current account and trade), state, municipal, corporate and household - is maintaining the U.S. housing bubble. Anything less would result in America's worst nightmare and, in short order, the entire world. The housing market is dominated by Fannie Mae and Freddie Mac who hold 75% of all outstanding home mortgages (and the Federal Home Loan Bank Board to a much lesser extent). One too many additional increases in the Fed rate may well turn out to be the U.S. economy's Achilles' heel and lead to a major crisis at these two institutions generating an out-of-control systemic breakdown situation and disastrous financial implosion.

The Fed is between the proverbial 'rock and a hard place.' They engineered low interest rates in the first place, both to keep the financial markets going, and in large measure to keep the housing bubble afloat. They are now in the final stages of raising interest rates to prop up the collapsing U.S. dollar and to forestall rampant inflation. Were they to initiate one quarter percent increase too many it would destroy the interest rate environment that is essential to keeping the housing bubble alive; to keeping consumers spending at a high level thereby keeping the economy growing; to keeping corporate sales and profits high thereby keeping the stock market healthy. Have they gone too far already? The bubble seems to be loosing air slowly at this point but what will the impact be of the next increase? The impact of one too many rate increases on such a chronically debt-ridden and maladjusted economy must not be over estimated.

It is just a matter of time before further increases in mortgage rates will result in increases in monthly mortgage payments than some borrowers cannot handle. This will be particularly so for borrowers of sub-prime loans who were able to purchase their first homes with almost nothing in the way of a down payment and who, even now, have a delinquency rate at near record levels. In addition, as mortgage rates rise further, fewer first-time buyers will be able to afford to buy a home which will, in turn, slow down the sale of new and resale homes.

Indeed, the Fed are so concerned about this happening they are flooding the economy with almost limitless liquidity. There must be a crisis of historic proportions coming, and the Federal Reserve Bank of the United States is making sure that there is enough liquidity in place to protect our nation's fragile financial system. The amazing thing is that the Fed's actions mean they know what is about to happen.

That could be it?" Perhaps the Fed finally recognizes that the housing bubble has experienced a leak that could well escalate into major proportions soon. Perhaps the Fed has learned that one (or more) of the 3 American banks holding 95% of U.S. derivatives are experiencing some difficulties managing their risks. Perhaps Fannie and Freddie are encountering major derivative losses once again. Perhaps the Fed are concerned that the rising budget deficit and/or the ever increasing and already record-high current account (trade) deficits are very near the tipping point. Perhaps it is their fear that the recent and continuing interest rate hikes are going to have a very negative impact on the already overly indebted U.S. consumers (rising mortgage, lease and credit card rates), the stock market (lower corporate profits) and the bond market and lead to a recession. Perhaps the Fed sees their greatest fear of all - deflation - just around the corner.