Now consider the effects of all of this home equity appearing out of nowhere for millions of people in Los Angeles. How much money was created? Well if there are one million households in LA and if each house recieved $300K of new equity, that is 300 billion dollars. The total amount of new equity created in the US is a few trillion dollars. The effects of a few trillion dollars introduced into the economy can't be ignored. Many of people would pull money out of their homes though a home equity loan. They would use this money for home repairs, new expansions, to buy cars or pay off loans or credit card debt to free up these cards for new purchases. All this new money flooded into the economy. Much of it ended up in bank accounts which helped fuel new lending. As prices rose further and further, houses became unaffordable to most with traditional loans. But banks would not allow the party to stop. New products were dreamed up that allowed anyone to buy a house regardless of credit quality or lack of down payment. These were the interest only loans, the adjustible rate mortgage (ARMs), the negative amortization loans, the option ARM, stated income loans etc. As long as prices were rising, even poor credit buyers could sell at a profit if they couldn't keep up with payments. Banks themselves were not at risk as long as prices rose even if they put their own capital at risk through second mortgages (piggyback loans). Non-bank subprime lenders would originate multitudes of loans to poor credit buyers and sell these loans off to Wall Street banks who would send them along to hedge funds looking for high yield products where they could could make huge profits by buying these with large amounts of leverage, some of which was generated by borrowing yen at near zero rates, selling yen for dollars and buying high yield US mortgage loans. When the bust started, the Wall Street banks stopped providing capital to these risky subprime lenders who collapsed due to this liquidity crisis. This reluctance of banks and non-bank lenders to lend would further add pressure to the collapsing housing market. The end game is now obvious. This housing collapse will be the worst since the 1930s. The bubble is bigger than previous bubbles in the 70s,80s and 90s. The collapse will therefore be worse. Some people still hope that Washington or the Fed can still save housing and save the economy. Unfortunately, the only solution is for prices to come way down. In the meantime this will lead to a miserable economy, higher unemployment and probably a severe banking crisis. The Fed can probably bail out banks if it chooses to to prevent a deflation like the 1930s by lowering rates close to zero which would allow banks to make large enough profits on the spread to cover real estate losses. However it can't make people spend like they did before. It can't restart the boom. It is time finally to face the music and deal with the fact that our economy cannot grow at these unsustainable rates of past years.
