Assuming for a moment that Alt-A might be in more trouble than the Fed would have us believe, what policy steps will follow from it?
- A major Alt-A lender is leaned on by large banks as Alt-A mortgages they sold to be packaged into CDOs begin to default at higher rates than predicted in the computer models. The lender implodes as their cash flow can't handle the new costs.
- Foreclosure rates spike. Protesters, politicians and furious home "owners" work to oppose quick foreclosure. Property sits occupied, but no cash flow is generated for the banks or CDOs as the legal process drags on.
- Laws are passed to slow the foreclosure process even further. Some states emulate an Ohio effort to allow ARM holders to refi at 6.25%, but soon learn that they are now holding the bag on a lot of bad paper
- "Squatters Rights" movements gain strength in Colorado, Ohio and Michigan. Legally or otherwise, property rights are thrown into question. Imagine for a moment what that does to local and county property taxes - and the people who rely on a salary taken from that tax revenue...
- The supply of housing has grown so much that demand has no hope of clearing it out in any reasonable time frame. Layoffs hit the building trades, further hurting potential buyers. Laws are passed in several states to hire gangs of unemployed to tear down houses that have stood empty for more than 18 months, in an attempt to reduce supply.
- A new version of the Resolution Trust Corporation is formed. This one allows for groups of "buyers" to purchase blocks of properties with minimal equity input and on balloon notes, in an attempt to further clear out the backlog of unsold inventory. Home prices collapse as the oversupply of homes and new access to credit competes with an oversupply of apartments. If you have a job, rent is cheap.
- Just as real estate settles out, funding crises hit the federal government as the Medicare program approaches complete insolvency. This hurts the pocket books of citizens as taxes are hiked and further limits their ability to bid up home prices.
- Home prices stay low for a generation. David Lereah writes a book "The Eternal Slump - Why Housing Will Never Recover". The bottom is hit, prices rebound and the cycle begins again.
If we get a positive divergence from the above, then we will have weathered the storm and I can let my sphincter relax a little until the Welfare State Bankruptcy Crisis hits in about five years.