Housing market: let's take the stock of the situation

Since the housing market is heavily influencing (negatively) stock markets, it may be useful to sum up the reasons of these influences and some hypotesis on how the situation will evolve.

The first and main problem are so-called subprime mortgages, i.e. mortgages granted where there is higher risk of insolvency,generally due to one or a combination of factors, including credit status of the borrower, income and job history, and income to mortgage payment ratio. Il looks like that sometimes the expected houes value increase was also calculated as part of the income, to “help” borrower meet requirements. But house value increase couldn’t be steady, and now houses reached a too high price not to have a reduction in demand.

One relevant factor is the (inevitable) increase in FED rates, that have been very low in the past few years, that is bringing an increase in mortgages rates and payments. Some subprime mortgage owners can’t afford payments: this starts a vicious circle since house are auctioned to get money back. But this kind of auction aims to sell quickly, not to sell at an high price. If

Said this, we can make a few hypothesis for the next future. Optimistic one: subprime mortgages crisis is mainly a USA phenomenon (as also Bank of England underlined a few days ago), and even if housing market in Spain and England may look to be starting to wear thin, in most european countries there are no high risks (especially compared to USA), since mortgage laws and rules limit the subprime lending, and also for a whole different approach to credit (it’s quite uncommon in many european countries to start a mortgage for anything different from buying an house). Moreover, econonic growth seem to be relatively strong both in Europe and Asia, so impact on the “real economy” should be limited. So, from this point of view, we could expect a limited impact of subprime crisis (resulting in a stock market correction), most of all considered that several states of the USA have started supporting actions for homeowners in difficulties.

But we have to consider also a worse scenario. First of all, subrpime mortgage sector in USA is definitely huge (several thousand billion dollars), and therefore it may impact the whole USA economy, beyond housing and stock market. Moreover, there are a lot of highly leveraged securities (owned mostly by hedge funds) that, related or not with subprime mortgages, not only multiply gains, but also losses. This could lead to the collapse of some hedge funds, that could start a chain reaction (also in cosequence of forced sales) since the massive capital hedge funds manage.

It is mostly leverage that worries Europe, and today — even if this is surely not a “red alert” — an ECB bullettin gives a lot of attention to leveraged buyouts, that could feel the aftereffects of a confidence decrease.

In conclusion, talking about Europe, there is no reason to be seized by panic, but neither to be excessively optimistic on the short term. The best thing one could do by now is to keep eyes open, to understand if we are in the optimistic scenario (market correction) or in the worst one (chain reaction).