Kass: The Simple Math of Subprime's Slide

"We've been anticipating a price correction and now it's here. The price drop has stopped the bleeding for housing sales. We think the housing market has now hit bottom." -- September 2006.

"This may be the bottom. It (housing) appears May is a little better." -- May 2006.

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1928-29: Simmons and Fisher forecast continued stock market gains in the fool's paradise prior to The Great Depression of 1929.

"I cannot help but raise a dissenting voice to statements that we are living in a fool's paradise, and that prosperity in this country must necessarily diminish and recede in the near future." -- E.H.H. Simmons, president, New York Stock Exchange, January 1928

"Stock prices have reached what looks like a permanently high plateau. ... The end of the decline of the stock market will probably not be long, only a few more days, at most." -- Dr. Irving Fisher, October 1929 and November 1929

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To be sure, I am not looking for a depression in housing or for the economy -- but those who look for housing to stabilize and for an increasingly restrictive mortgage credit market to be anything other than a substantive drag on 2007-08 aggregate economic growth are just plain wrong.

It's sometimes fun to go back and look at several of the above mistaken views and hyperbole from those who should have known better, but it is even more worrisome to look at the state of housing demand and supply today, which leads to my broader economic concerns:

The explosion in mortgage delinquencies in the second half of 2006 has only recently begun to be converted from delinquencies to foreclosures (and for-sale signs). Currently, the housing market's foreclosures stand at a 40-year peak.

Economy.com estimates that there were about 400,000 foreclosures in 2006. With signs of continued rising delinquency rates thus far this year, 2007 foreclosures should be considerably higher than last year's figures. I would estimate that foreclosures in 2006-07 will add nearly 1 million units (or 26.5%) to the current level of 3.75 million homes for sale. Stated simply, most are underestimating the massive supply of homes that will be dumped on the market over the next year to two years.

While record foreclosures will assuredly lead to a rapid rise in the supply of homes available to be sold in 2007 and 2008, tougher lending standards (particularly in the subprime category that is the lifeblood of first-time buyers) will squelch housing demand. Historically, creative lending (option ARMs, interest-only, negative amortization, etc.) shored up the housing markets by allowing (indeed encouraging) otherwise unqualified borrowers to participate in the roaring residential market of the last few years. (I suppose that Anthony Hsieh, CEO of Lending Tree, might now have second thoughts regarding this quote back last year: "If you own your home free and clear, people will refer to you as a fool. All that money sitting there, doing nothing."

First-time buyers and speculators, who, before delinquencies mushroomed, were qualified for high (95% or more!) loan-to-value mortgages at below market interest rates (80% of subprime loans over the last three years were 2/28 ARMs) based on teaser interest rates are now being qualified increasingly by the mortgage interest rate charged after reset.

This is serving to effectively price out a major demand source for homes as they are no longer eligible for low down-payment, nondocumented loans that were previously granted with below market or teaser interest rates. Indeed, subprime mortgages have been the only source for a large amount of homebuyers in the last three years. No more.