What created this recession in the first place? People were sold mortgages they couldn’t afford. Payments caught up to them because the interest rates reset. Had they gotten fixed rate mortgages they wouldn’t have had this problem. Of course, had they gotten a fixed rate they probably wouldn’t have been able to afford the house.

During 2006 and 2007, we had a flood of loans reset, mostly of the subprime variety. This is why we call the financial crisis the subprime crisis. By the time we got out of 2008 the subprime resets were over and most of the other types of loans were in decent shape.

But now we have new problems. Housing prices have collapsed. People still can’t afford to make payments, and it’s getting worse due to unemployment. We’re in a slow recovery, but it’s like trying to hide a red cape from a bull already standing inside a china shop. Don’t piss him off.

There are a number of bulls in the shop. Consumer confidence is tanking, house prices continue to fall, unemployment isn’t going down, commercial real estate is an abomination, foreign governments are running out of money, etc…

The last thing we need is one more thing to worry about. But what if the thing that got us in this mess comes back to bite us in the butt again? Take a look at the chart below.

This is from a presentation in 2009. I’ve taken the liberty to update the graph with a new “you are here”. If you don’t know how to read this, the higher the graph goes the more mortgages will be reset at that time. In other words, 2011 has the potential to be a bad year. And if you think it was only subprime loans that caused this problem, think about the option arms. They have the potential to be worse because they gave homeowners the option to make small payments each month. So small that with each payment, the balance on the loan goes up! Alt-A mortgages are less risky than subprime, but more risky than prime. But prime is hardly good if the person is underwater and now unemployed.

We could end up with another credit crisis in 2011. That makes 2010 a race against time. What’s the race? We have to get people back to work, stabilize home prices, and start spending. If this doesn’t happen 2011 and 2012 may be as bad as 2008 and 2009.

I’m not saying this to be pessimistic, in fact, I’m quite optimistic about the future. I just don’t want to get too optimistic. The one thing that has and will continue to help is the low interest rates. This is why The Fed will probably not hike rates anytime soon. Each increase of 0.25% (or 25 basis points) in the funds rate probably equates to some number of people not being able to afford their homes anymore. Will any of these people refinance? I hope so. Are they still working and can maybe fit in these payments? I hope so. But don’t think it’s all safe and all we have to think about is a slow recovery. We could still get pulled right back to 2007.

By The Weakonomist

The Weakonomist is the founder of Weakonomics. Clicking the picture of the puppy will tell you more about him. If you like what you're reading consider subscribing to the blog, following him on Twitter, and checking out the related posts below. Please consider a donation if you really enjoy Weakonomics. Also keep in mind that nothing I say can be construed as financial advice.

categories: banking, business, economics, loans