Why Worry? Everything is Fine… So They Tell Us

New Century Financial Corp., the largest U.S. based lender to subprime borrowers, filed for Chapter 11 bankruptcy on Monday. The company, which last year earned $60 billion in home loans to poor-credit borrowers, will lay off 3,200 employees. No longer will people with not-so-great credit find it easy to finance a new home purchase. The stocks of the biggest home builders in the U.S. have been in a nose dive for months — an advance indicator of more trouble ahead for U.S. housing.

The yield curve has now been inverted for seven months in a row. Historically, when the yield curve is inverted (short-term bonds pay higher than long-term bonds), we subsequently experience a recession.

Jeff Rubin, an economist with a unit of CIBC, said yesterday the U.S. subprime crisis will deepen and eventually cost $100 billion. I’ve always believed the subprime meltdown would affect other lenders and the U.S. economy. $100 billion is a big number, but it’s too conservative in my opinion. How do we measure the effects on the economy of poor-credit home buyers who can’t buy homes anymore? What happens when demand for any item declines? Prices decline.

According to the S&P/Case-Shiller home price index, U.S. home prices fell in January 2007 from January 2006 — the first time prices have dropped year-over-year since the index was created back in January 2001. If home prices fall too rapidly in the U.S., home equity will be eroded. In the case where home owners put no money down in 2005 or 2006 for their home purchases, they could be tempted to simply hand their keys to their lenders and walk away. This was a common practice in 1986 in the U.S.


But we don’t have to worry… Everything is fine… Or that’s what Wall Street is telling us, what the general stock market is telling us, and what central bankers (current and retired) would have us believe.

My dear reader, the demise of the American economy, and the beginning of a home-made recession, is well underway… all courtesy of a hard landing in the U.S. housing market.