Mortgage Paradigms

     Ten years ago the tech bubble burst and a huge amount of money that had been invested in tech stocks disappeared. This had a modest negative effect on the economy. More recently the housing bubble burst and a huge amount of money that had been invested in real estate disappeared. This devasted the economy. Why the difference?

     When the housing market first began to crack it wasn't expected to have such a large impact. The paradigm was of a poor family who had been sold a house they couldn't afford with a subprime mortgage. This couldn't destroy the broader economy. The money they borrowed to buy the house, as well as whatever mortgage payments they did make, was tied up in real estate, and not available to the broader economy, the same as the money that had been tied up in tech stocks a decade earlier.

     Later, problems spread far beyond the poor and far beyond subprime mortgages. Now the paradigm seems to be a homeowner who can't pay his mortgage because he lost his job. But there have always been people who lost their houses because they lost their jobs and if there are more of these people today, they are the victims of the bad economy, not its cause.

     The reason the bursting of the housing bubble devasted the economy is the virtual disappearance of home equity loans(and cash-out refinancing). As housing prices dropped, the collateral that had supported home equity loans evaporated and so did the loans. The money from these loans that had poured into the broader economy from real estate has now disappeared, and with it the much broader economic bubble that it had inflated. Just like living well off money borrowed from credit cards which ends at the cards' credit limit, the party stopped when homeowners couldn't borrow any more money on their homes. The most meaningful paradigm is that of a homeowner who was on the PBS Newshour. She once had an $86,000 mortgage that she ran up to $240,000 through home equity loans or refinancing. She is now in danger of foreclosure and hopeful of "repurchasing" her home from the lender for $80,000 on the theory that this is all the lender could get through a foreclosure and resale. Cases like this are what have caused the economy to unravel.