Democrats expect the economy to help them out in November. As The Washington Post put it this week, " 'Mortgage Moms' May Star in Midterm Vote. With Wages Stagnant and Debt Growing, Democrats See an Opportunity." Well, if mortgage moms are already stressed out, you have to wonder how they might be feeling a year from now. By then, the chances are good that they will have a lot more to worry about. If it's true that the economy is going to help the Democrats this year, and it probably is, the boost may be nothing compared with the push it will provide in 2008.
Today, after all, economic growth is steady, unemployment is low, and inflation is subdued. This is not to deny the financial stresses that so many Americans complain about. Median incomes are growing only slowly—more slowly than the prices of health care, a college education, and gasoline, for instance. Still, for now, the overall economic picture is bright.
This may soon change. The chances of a recession seem to be rising. And you could say that mortgage moms—stars of the economic outlook as well as of the forthcoming elections—are the reason why.
Mortgages and other kinds of debt explain how the last recession turned out to be both brief and mild. Alan Greenspan, then-chairman of the Federal Reserve, responded to the bursting of the tech-stock bubble in 2000 with deep and prolonged cuts in interest rates. As a result, consumers kept on spending, notably on houses and on related goods and services—and got themselves deeper and deeper in debt to do it. The Fed's policy worked exactly as it was supposed to, in the first instance, because the economy quickly recovered. But the full story of the tech-stock bubble and its aftermath is by no means over.
During the past five years, encouraged by those post-bubble interest rates, not to mention the tax deductibility of mortgage interest payments, American households have got themselves in debt up to their eyeballs. Mortgage debt alone has approximately doubled in the past six years. While housing prices were rising at double-digit rates, all those loans weighed lightly on households. Net worth was preserved, or even continued going up, despite the burden of increased debt, and despite the fact that much of the borrowing was used to finance consumption, not investment. But mortgage moms and dads are no longer taking it for granted that housing prices will keep rising so fast. Housing prices are now stalling. In many real estate markets, they have dropped, and household net worth is falling along with them. According to the most recent figures, sales of new homes are running 22 percent below the same month last year. Inventories of new homes are up by about the same; inventories of existing homes are 40 percent bigger than a year ago.
Those debts are looking heavier by the week. This would be enough by itself to cause households to cut spending and start saving, thus slowing the economy down. But there's worse. Traditionally, American mortgages have been granted at fixed interest rates. Lately, banks and other lenders have fueled America's appetite for credit with aggressive sales of new kinds of loans. These loans typically have lower payments at the start and higher payments later, and they expose borrowers to greater risk if interest rates rise. These variable-rate and interest-only mortgages are much more hazardous than the old-fashioned kind. The recently popular "option-ARM" (for adjustable rate mortgage) takes it to an extreme. The debt does not get paid down promptly. In the early years, these loans even let borrowers pay less each month than the interest due, with the difference added to the principal. For borrowers who don't know what they are doing—and, to judge by some of the horror stories published lately, that is more than a few—the option-ARM is a formula for financial ruin.
Interest rates have risen in recent months but, in inflation-adjusted terms, they are still pretty low. So far, the housing market has slowed but it has not collapsed. Nonetheless, defaults are already rising, and many borrowers with interest-sensitive mortgages are in trouble.
Apparently a lot of people continue to take comfort in the remarkable fact that median house prices in America have not fallen on a year-on-year basis since the Great Depression. Speaking as the owner of a mortgaged property, I would like that fact to hold as an eternal truth. Unfortunately, I don't expect it to. That is partly because house prices are further out of line with other prices than ever before, and partly because I have seen housing prices crash in other markets—markets, such as Britain's, which have relied more heavily than the United States has, up to now, on variable-rate mortgages. Nothing puts a market into a rapid fall more reliably than homeowners forced to sell. Britain's most recent housing crash, in the early 1990s, was brought on by a spell of high interest rates, which made the debts of many variable-rate borrowers unaffordable. Many chose to sell rather than default. (Those left without equity in their homes as prices fell were ruined in any case.) The recent popularity of variable-rate and other high-risk mortgages has exposed many Americans to this danger for the first time.