If you paid attention in Econ 101, you probably remember that when interest rates climb, sales volume declines, and prices naturally fall.
But that’s not happening in today’s market.
So what could drive this deviation from the natural market effect that we’ve seen consistently play out for as long as we’ve traced this kind of data? A timeframe spanning hundreds of years, by the way.
The short answer is that the federal government has enabled borrowers to take out increasingly larger mortgages than they can afford by conventional financial standards. To add fuel to the fire, it’s also bailing them out when they miss their payments. This was a transparent attempt to cook the books to make the economy seem better than it was throughout the Biden administration.
Welcome to our next subprime housing bubble. The underlying data shows that this one will make the 2008 bubble pale in comparison. The economic impact will be devastating, and not only for the people directly involved in these foreclosures.
These problems began under the Obama administration, when officials eased underwriting guidelines, enabling more home buyers whose debt liabilities exceed 43% of income—a threshold traditionally considered a red flag for lending risk, to qualify for government-backed loans.
It then metastasized into unprecedented government manipulation of the housing market that artificially drove prices up and masked an alarming rate of missed payments. And as home prices climbed, the Biden administration doubled down on this program, further exacerbating the economic problems brewing just below the surface.
In 2007, 35% of new FHA borrowers had DTI, or debt-to-income ratios, above 43%. This number is already too high, but by the end of Obama’s second term in 2016, it had climbed to 54%, and today, that number has skyrocketed to over 65%.
This is not the free market. It creates an artificial market that is not based on reality and is prone to extreme volatility and abrupt collapse. These programs created an environment where foreclosure became extremely costly and nearly impossible. Banks are incentivized to approve risky borrowers for loans they can’t afford, like actions preceding the 2008 crash. The result is a housing market that looks stable on the surface but is just being held together by taxpayer subsidies and a complicit media industry.
So, just how bad is this problem?
The FHA mortgage program oversees 7.8 million active loans today, and nearly 14% are currently in default. This means that over 1 million homeowners in this program are currently behind on their payments. Our government has covered this up. The FHA made 556,841 “incentive payments” to servicers over the past year to prevent foreclosures—nearly as many as the new mortgages it insured.
But the problem doesn’t end there. Today's loan portfolio held by the FHA is far more risky than it was leading up to the 2008 housing crisis, which decimated the real estate market and related industries. The American Enterprise Institute’s Ed Pinto and Tobias Peter estimate that 79% of FHA first-time borrowers have one month or less in financial reserves—this is nowhere near enough to make even a single mortgage payment if their household expenses rise, as almost everyone has already experienced due to an increasing cost of living driven by inflation.
This hurts Americans on multiple levels.
The first is the homeowner. You might wonder how a program whose creators claim it is designed to help homeowners could actually harm them. That’s a fair question with a simple answer.
First of all, it allows them to purchase far more homes than they can actually afford, which puts them in a far riskier financial position. It’s kind of like giving a toddler a bottle of whiskey and a gun and hoping for the best.
Think about this—if a borrower misses five $4,000 monthly mortgage payments, the servicer will add the $20,000 in missed payments to the mortgage and reduce monthly payments by $1,000 for a period of three years, adding another $36,000 to the end of their mortgage.
So the borrower is now $56,000 deeper in debt, and if he misses payments again, the servicer will go through the whole process again, adding additional debt to the mortgage. The FHA also lets servicers charge borrowers legal fees, typically several thousand dollars, that are also added to the mortgage principal.
It’s not hard to see how this can quickly spiral out of control. But let’s not forget the downstream effects that have historically come from situations like this. The impact soon spreads far beyond the homeowner facing foreclosure.
That foreclosure also directly impacts the lender, and with enough foreclosures on their balance sheet, they will be forced to start laying people off, and their stock price will likely be affected as well. This means fewer people contribute to the economy because they have no income.
Still, it also means even further increased financial insecurity because their retirement accounts are now declining in value due to a crumbling stock market. With fewer Americans in the workforce, Americans will start to cut back significantly on spending, and soon, other companies utterly unrelated to the real estate industry will also be affected.
In other words, this affects all Americans at all income levels, and the problems continue to expand out from here.
A growing number of foreclosures, combined with fewer transactions in the market, leads to declining home prices. Now, homeowners who need to get rid of a property immediately will be forced to take a loss. This also means that Americans’ net worth will further decline because, for most, their home is their largest asset. It quickly snowballs into a wrecking ball-sized problem that wipes out vast swaths of our economy.
I’ve covered this situation in articles here at Newsmax, outlining how this has played out during previous economic downturns, but this one is worse on all accounts.
Wages have remained stagnant for years while costs have continued to rise due to inflation, pinning many Americans into a no-win situation. Right now, we’re facing a proverbial perfect storm, because in addition to those factors, we’re also facing a debt crisis driven by out-of-control spending.
To put this in perspective, the revenue needed to run our country is about 7 trillion dollars per year, but we only take in about 4 billion dollars per year, piling onto our already staggering 36 trillion dollars of national debt—and the House just put forth a bill to raise the debt ceiling by another $4 trillion. The interest on our national debt now exceeds our entire military budget each year.
Unfortunately, the solution will require some financial pain; frankly, I don’t know if most Americans have the financial discipline for that.
There’s zero question that winter is coming for the real estate market. Interest rates will remain high and are likely to increase further. Underwriting guidelines will tighten, making it harder to get qualified. Home prices will likely stay at current levels for some time, but will be driven down by reduced demand because people can’t afford homes, and/or don’t qualify for mortgages. This black swan event is set to destroy our economy for decades unless we take drastic steps to reverse course very soon.
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Dr. David Phelps created Freedom Founders to help its members achieve the freedom they wanted in their lives by building the necessary financial foundation. He is a noted financial expert who is regularly cited by the media, and recently helped the FL Dept. of Education develop its new financial literacy curriculum.