Columnist: When the U.S. housing bubble bursts, it will not burst gently

In fact, Koza says, he doesn't buy into official housing statistics at all.

"Official statistics are so massaged and seasonally adjusted and weighted-averaged and smoothed that I often find them hard to believe," the Canadian markets analyst for Thomson Financial says. For example, official National Association of Realtors statistics predicted a 6.1 percent rise in the national median house price in 2006. The actual national median house price was still down 2 percent between January and November of 2006, but Koza notes that market experts have called the drop as a "healthy correction" and not a predictor of drop in house prices. "At least, not yet," Koza says.

Koza is of the opinion that the U.S. housing market might be in the process of collapsing, but says that evidence for the decline is only available "on the margins of the housing market." The margins are the realm of subprime mortgages: high-interest-rate mortgages given to buyers with credit problems, ostensibly to compensate for the risk of lending to them. Unlike prime mortgages, Koza says, subprime mortgages do not produce odds that necessarily favor eventual loan repayment.

An indicator of the decline in housing prices is the fact that subprime lending has been growing 25 percent every year between 1994 and 2003, Koza says. Mortgage companies made $900 billion in subprime loans from the beginning of 2005 to the third quarter of 2006, Koza reports, and 80 percent of all subprime loans were option ARMs, according to September 2006 numbers.

"ARMs usually have features like "minimum payment options" (the principal you owe gets bigger over time), or "interest-only" payments (you never pay it off and had better hope house prices only ever go up)," Koza says. "One out of every three home buyers in the first eight months of 2006 got some kind of pay-option mortgage -- that's up from one in five in 2005 and only eight out of a thousand in 2003."

According to Koza, another name for ARMs is 2/28, stemming from the fact that the first two years' payments stay low, but the payments for the next 28 years shoot up 40 or 50 percent. Estimates are that at least $1 trillion in option ARM payments will increase this year -- that is 41 percent of all option ARMs -- and Koza says he has seen estimates as high as $2 trillion.

Because the interest rates of subprime loans are designed to offset the risk of lending to people with poor credit, they are often approved through a "low documentation" process, Koza says. This means that obstacles for a customer seeking loan approval -- no job and no down payment, for example -- don't serve to disqualify that person from a large loan, because the lenders don't ask for that information. Koza reports that, in 2006, 38 percent of subprime mortgages lent 100 percent of the house's cost, and 12.5 percent of all subprime mortgage buyers were delinquent on their payments after nine months, according to statistics for the third quarter of 2006.

The scary part about these numbers, Koza says, is that lenders usually try to get these high-risk loans off the books quickly by securitizing them, packaging them and selling them to investors, but one out of every five subprime mortgages from the last two years is going to go into foreclosure, says Koza, citing a study by the nonprofit Center for Responsible Lending. If that happens, roughly $74.6 billion in homeowner equity will go up in smoke as banks repossess about 1.1 million houses, Koza says.

"The banks will sell the repossessed properties as quickly as possible, driving house prices lower, triggering more foreclosures, putting more excess properties on the market, driving prices lower and, well, you get the idea," he says. "Now, I'm not saying this is going to happen -- only that it could, and while bubbles are lots of fun when they are inflating at exponential growth rates, let's hope we don't have to find out just how ugly this one can be when it is deflating exponentially."

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