My Two Cents

The Subprime Market Concern Overblown

Chris Farrell Mar 16, 2007

The subprime market is imploding. Home foreclosures are surging. Millions of new homeowners could be thrown out on the street. So, it’s hardly surprising that a growing number of economists are raising the recession alarm. For instance, Stephen Roach of Morgan Stanley says “subprime is today’s–the pin that pricks a much larger bubble.” Seven years ago, the bursting of the bubble eventually swamped the rest of stock market, and the economy tanked into recession.

Now, I’m not a card carrying member of the Pollyanna Club. But it seems to me that the economy remains primed for growth. The Fed has a lot of experience dealing with crisis in the housing and mortgage markets. If the subprime market’s credit woes spread to the rest of the credit market the Fed can always cut its benchmark interest rate and flood the system with liquidity. I like the slant Mike Mandel, chief economist at Business Week, has on the current situation.

He says if you want to worry, fret about the slowdown in productivity growth. (I would add too much bad investment in China; someday there will be a day of reckoning.). But Mandel argues to keep the subprime market is going through a correction, not a meltdown.

So the real question to ask is this: How does the crisis in the subprime mortgage market stack up against previous meltdowns? Is this going to be the Big One?

The short answer is, not likely. In a Feb. 20 speech, Federal Reserve Governor Susan Schmidt Bies estimated that subprime adjustable-rate mortgages, which are the heart of the problem, make up just 7% to 8% of the total home mortgage market. Still, in absolute terms the size of the defaults could be enormous. Some estimates suggest that banks and other lenders could take a hit of $300 billion or more.

But remember, the tech bust devoured about $9 trillion in corporate equity; next to that, the subprime problem looks like an insect bite—unless it spreads to the rest of the mortgage market. But at least so far that doesn’t appear to be happening: Mortgage rates for good borrowers have actually been going down. In early February, for example, the average rate for 15-year fixed rate mortgages was 6.06%, according to Freddie Mac. As of Mar. 8, that was down to 5.86%. If low rates continue, they should actually prop up most of the housing market (see, 2/19/07, “Out of the Basement for Housing”).

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