Business USA: The Housing Abyss

The housing crisis is entering a new and frightening stage. On June 24, Standard & Poor's announced that the S&P/Case-Shiller 20-City Home Price Index had fallen more than 15% in April from a year earlier. Adjusted for inflation, the decline is the biggest since 1940-42, according to data collected by Yale University economist Robert Shiller.

The risk for the financial system and the economy is that the price drop, already horrifying, will start feeding on itself. When home values fall low enough, hard-pressed homeowners become less able or less willing to keep paying their mortgages. That forces lenders to repossess homes and then dump them back on the market at fire-sale prices, which depresses prices further and leads to even more foreclosures.

That process has already started in parts of Arizona, California, Florida, and Nevada. The drop in those markets "is being fueled with jet fuel," says James L. Smith, executive vice-president for portfolio services at Fiserv (FISY), a Brookfield (Wis.) company. His unit works with borrowers to restructure delinquent mortgage loans. Smith worries that instead of settling at a reasonable price level, "we're going to blow past [it] without even looking back."

Efforts by the private sector and government to stop the slide before it gets out of control haven't done the job. Poorly designed mortgage securities rife with conflicts of interest, as well as legal disputes over priority between creditors, are forcing many homes into foreclosure needlessly, accelerating the market decline.

Sure, Congress is expected soon to pass a huge legislative package aimed at preventing needless foreclosures and stimulating first-time home purchases. But many analysts and advocates are already warning that more dramatic measures will ultimately be required. "The depth of pain is not being registered in D.C.," says Mike Shea, executive director of nonprofit advocacy group ACORN Housing in Chicago.

That's not everyone's assessment, of course. Some economists and politicians say that policymakers need to focus on keeping inflation under control in the face of soaring food and fuel prices. They say that the effects of the housing bust will be modest and that low prices will attract new buyers. "We're seeing people go into the market that weren't there before," says Alfred A. DelliBovi, president of the Federal Home Loan Bank of New York. The Federal Reserve, which has already cut the federal funds rate to 2% without managing to save the housing market, hinted on June 25 that no further rate cuts are in store, warning that inflation risks have risen while the risk of slower growth has "diminished somewhat."

by Peter Coy and Mara Der Hovanesian
Full Story: http://www.businessweek.com/print/magazine/content/08_27/b4091032364818.htm