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Special section Mortgage reset

Adjustable mortgages with low introductory rates were the rage, but now the teaser rates are running out.

What is a reset?

Formula for foreclosure: resets, no equity
 

Cagan says his forecast is "based on conservative recession conditions. I'm trying to do the most intellectually honest, go-ahead-and-get-the-magnifying-glass-out way of doing it." The problem might not turn out as bad as he predicts, or it might be worse. Under his model, every 1 percent drop in the national average home price would lead to 70,000 more foreclosures over several years.

Shakeout seen in Vegas, Florida
Dean Baker, an economist who has had a bearish view of housing for years, says Cagan's analysis is fundamentally sound. "The main point I would emphasize is that he's basically looking at scenarios of flat or modest falls in prices," Baker says. That's important, because "we aren't going to have the same situation everywhere, but the markets with the sharpest price declines are precisely the places where you had a high concentration of these exotic mortgages."

Baker said he thinks places such as Florida's Gulf Coast and Las Vegas, where prices zoomed a couple of years ago, could see price declines of 30 percent to 40 percent over the next several years. Such markets will get caught in a vicious circle where prices fall, houses go into foreclosure, and prices fall even more because of the glut of foreclosed houses on the market, causing more foreclosures, and on and on.

The counterargument goes like this: The economy will weaken and interest rates will fall, boosting demand for housing. Immigrants and retiring baby boomers will sustain demand for housing. "I can't say I find these arguments very compelling," Baker says.

Other views
There are other estimates of the impact of problems in the subprime sector, and foreclosures that might result:

  • Stricter subprime loan standards could cause total home sales to fall by 100,000 to 250,000 units a year nationally, the National Association of Realtors says. The decrease in sales, the NAR says, won't be a huge problem: "Many of these households will probably, over time, purchase a home when they have attained the financial capacity to do so by saving for a down payment or growing their income," the trade group says in a news release.
  • Richard DeKaser, chief economist for National City Corp., says he believes a vicious circle of declining home prices and foreclosures will affect "a fraction of the housing market." He writes that "frothy markets vulnerable to price corrections account for only 16 percent of all single-family housing units and their share of the total U.S. market has been declining since the middle of last year."
  • According to Bloomberg.com, an economist for Merrill Lynch & Co. wrote in a note to investors that U.S. home prices could fall 10 percent unless the Fed cuts short-term interest rates.
  • New home sales could fall 20 percent from December's seasonally adjusted rate of 1.1 million units, and housing starts could plunge 35 percent to 45 percent, says Ivy Zelman, an analyst for Credit Suisse.
-- Updated: Oct. 1, 2007
 
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