I don't think the early stages of a housing-bubble deflation involve people being forced to sell their houses. It may not even involve financial ruin. But negative home equity could likely mean a sudden fall in consumer spending. People might actually decide to save some of their income for a change, or more accurately, to return the personal saving rate to its historic norm. If so, that intensifies any tendencies toward recession. That, of course, makes the housing melt-down worse.
Then we'd get the possibility of mass efforts to sell houses -- and financial ruin.
> Look at it this way, if you have the perfect storm:
>
> 1) You've stretched to buy a house
> 2) Interest rates rise so you can't make payments
> 3) Housing prices crash
>
> ... you're already in big trouble with 1 & 2. Without 3, sure, you
> could maybe sell the house and get out. But for people in the 1 & 2
> scenario, what's the chance that they got in too late? And what's the
> chance that their "only" problem is housing? What if they also have
> credit cards, and the $50k they clear on the house doesn't cover that?
> Where do we assign the blame for the disaster then?
The rise of interest rates doesn't affect the costs of the majority of mortgage-holders, since they are mostly fixed-rate mortgages these days. (A growing minority has gone for scary alternatives, but it's still a minority.)
If you sell your house due to this situation, by the way, it would encourage further falls in house prices.
NB: neither I nor anyone else who talks about the housing bubble see it as the "only" problem. The issue is that since 2001 a major force that first moderated the US recession and then encouraged economic boom was the growth of the residential construction industry. If the bubble deflates, that pulls a major prop out from under the economy. This means that the various elements of instability in the US economy -- such as the amazing amount of credit-card debt -- suddenly become more relevant.
> Don't forget: if you got in even last year, you might not be negatively
> affected when (if) "the music stops". Also don't forget: interest rates
> have been rising for well over a year ...
short-term interest rates have been rising. Long-term ones have not. This disjuncture is an element of instability in the US currently. Long- and short-run interest rates don't say apart for very long (in my experience).
In the current LBO, Doug suggests three reasons why long-run rates have been "weirdly down over the last year." (1) a worldwide glut of savings; (2) shy investors who would rather own long-run bonds (driving up their price up and their interest rates down); (3) bond investors expect an economic slowdown and/or deflation ahead.
It's possible that all three of these theories are true. All of them suggest recession is on the horizon. That would drive short-term rates down, more in line with long-term rates. Of course, there could easily be an upward spike in rates in the meantime, if there's some move away from the dollar toward the Euro on foreign exchange markets.... -- Jim Devine "Economics is extremely useful as a form of employment for economists." -- John Kenneth Galbraith