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The next shoe to fall

Much pain has been experienced in the American and world economy due to the collapse of sub-prime mortgages. This slow motion car wreck has resulted in:
  • massive commercial and investment bank write-downs,
  • the beginning of a series of bank closings,
  • destabilized the two largest mortgage guarantors, Fannie Mae and Freddie Mac, resulting in an explicit Federal guarantee for them
  • the recent federal stimulus package that has temporarily kept the economy from recession by borrowing over $100 billion from the Chinese and other holders of US Treasuries.
The sub-prime mortgages represent about 4-6% of the total $12 trillion US mortgage market and the damage they have caused so far seems to be worse than the damage caused by the meltdown of the S&Ls in the early 1990s. The S&L crisis was referred to as "the greatest collapse of US financial institutions since the 1930s", according to a Federal Deposit Insurance Corporation (FDIC) report issued in 2002. The sub-prime mortgage crisis appears to be nearing its end. The number of "resets" have been peaking and going down. But, there is another shoe left to drop... I have written about the overhang of drivable sub-urban houses on the extreme fringe of our metropolitan areas in The Option of Urbanism and in The Atlantic Monthly article, "The Next Slum?". They are the result of the de facto domestic policy that has been in place for over a half century that legally mandates and subsidizes development of single family homes on the fringe. The housing market is now demanding more and more walkable urban product, providing transportation choices in how to get there and a walkable community in which it is located. Many drivable sub-urban houses and the commercial that supports them will never be worth what it cost to build them. The land under these houses is worth less than zero. Arthur C. Nelson of Virginia Tech has estimated that 35% of the drivable sub-urban houses may be in this situation over the next two decades. Today in The New York Times, the front page story is entitled, "Housing Lenders Fear Bigger Wave of Loan Defaults". The sub-headline is "Economic Ills Take Toll on Higher Grades of Mortgages". This next wave is primarily caused by the fall of housing values on the fringe of our metropolitan areas. For example, the Los Angeles metro area had an annual price decline between May of 2007 and May of 2008 of 23%... a decline we did not even see in the Great Depression of the 1930s. However, West LA, which is a high density set of neighborhoods in the economic center of the metro area, saw slight price gains. The bulk of the housing value decline was on the fringe; Palmdale and Victorville, which are 40-60 miles from West LA, lost 43% year-to-year! The big question is how will the economy fare after taking a body blow from sub-prime mortgages defaults, which represented 4-6% of outstanding mortgages, if 10-20% of additional mortgages go bad in phase II of this crisis? The Federal Reserve and the US government seem to be out of levers to pull. Jim Kunstler is infamously known for saying "sprawl will be seen as the greatest misallocation of resources in history". He seems to have had amazing foresight. ———- Christopher B. Leinberger is a land use strategist, developer, teacher, consultant and author, helping to make progressive development profitable. He is currently a Visiting Fellow at the Brookings Institution in Washington, D.C. He is the author of The Option of Urbanism: Investing in a New American Dream from Island Press. Previous blog posts by Chris: