With so much talk of a housing bubble, I thought we should talk about the effects of a possible housing crash. While there are some obvious ones – an increase in foreclosures, for one – others aren’t as clear.
What is going to happen to the banks that have been one of the main reasons for the bubble? In order to compete with one another, mortgage banks have been issuing riskier and riskier debt. The seemingly unaffordable home has become affordable and then-some. It is so bad that beat-cops can afford million dollar homes (heard that story personally) – not that they don’t deserve mansions.
As rates continue to climb, yes, foreclosures will be abundant, but what does that mean? Banks will need to write millions and millions of bad debts off. Earnings will suffer, and some will quite possible go under. The effects will spread to the stock market as a result.
As for hopes that the stock market would take over for a flagging real estate market, “I don’t think it’s that simple anymore,” says Barry Hyman, equity market strategist with Ehrenkrantz King Nussbaum in New York. He points out that a bread-and-butter index fund based on the S&P 500-stock index now has significant exposure to real estate through the financial-services and consumer sectors.
The financial-services sector makes up 20% of the S&P 500 and has benefited from the mortgage refinancing boom driven by lower interest rates. This leaves companies in that sector vulnerable if trends reverse. In a Sept. 15 report, S&P credit analyst Victoria Wagner conducted a “stress test” on banks, assuming a 20% decline in home prices over two years (which she considers unlikely). The top 10 hardest-hit banks in that scenario included widely held stocks like Wachovia (WB ), Wells Fargo (WFC ), and JPMorgan Chase (JPM ).
Source: Business Week
There are indeed risky times ahead in the coming months and years. With this in mind, we can better prepare ourselves financially to handle any possibilities that arise.